Chapter 12 - Risk Management PDF

CHAPTER 12- RISK MANAGEMENT INTRODUCTION The world of business does not offer guarantees that specific outcomes will be achieved because of the high degree of uncertainty linked to: The economy of the country: Will there be economic growth or a recession? The economy on a global level: Inte...

CHAPTER 12- RISK MANAGEMENT INTRODUCTION The world of business does not offer guarantees that specific outcomes will be achieved because of the high degree of uncertainty linked to: The economy of the country: Will there be economic growth or a recession? The economy on a global level: International events affecting business in SA. Political developments: Corrupt government officials and state capture. Technological advancements: Ongoing technological developments leading to automation. Changes in legislation: Impacts like BEE and UIF. Changes in consumer demands: Customers moving towards healthier food options. Taking risks is a natural part of business, however, the entrepreneur or manager should be aware and actively plan for the variety of risks that exist as part of the everyday business operation and decisions that are taken. Risk management can be defined as analyzing the profitability of an event taking place and then proactive planning to minimize the possible negative impact of the event on the business. A business also wants to look at events that might have a positive outcome and then plan to capitalize on this. Risks can be seen in several ways: Risk is a mere uncertainty Risk as a threat Risk as an opportunity R I S K A N D S T R AT E G I C M A N A G E M E N T The objective of risk management is to ensure a balance between opportunities and threats. Risk management should be integrated into strategic planning. Strategic planning refers to the formulating of the business’ vision, mission, and value statement, organizational structure, as well as the goals and objectives. The business operations include aspects such as implementing policies, managing processes, monitoring and controlling daily activities, and satisfying the needs of customers to ensure profitability. Risk management is implemented to ensure the strategic plan and business operations are aligned.  Strategy: (vision, mission, value statement, organizational structure, goals and objectives) Risk management: The alignment between business strategy and business operations Business operations: Implementing policies, managing processes, monitoring and controlling daily activities RISK MANAGEMENT IN PRACTICE The way a business views risk is influenced by a business risk profile and risk culture. RISK PROFILE: Refers to the degree that a business is willing to accept risks in pursuit of creating value or to achieve business goals. The risk profile is directly related to the strategy of the business. Any business should try to achieve a balance between business growth, possible returns, and risks. RISK CULTURE: Described as shared attitudes and practices in the business. In a similar manner, the risk culture of the business refers to the collective attitude in the business accepting risks. The risk culture within a business is the result of businesses is the result of business practices such as results for risk-taking or risk avoiding behavior.  Operational risks Reputation Country al risks risks TYPES OF Types RISKS of risks Strategic Environmen risks tal risks Financial risks OPERATIONAL RISKS: COUNTRY RISKS: The risks associated with the The risks associated with internal operations of the operating/locating the business may include risks business in a particular that involve: country centers around: Systems/processes Political events Organizational structures Economic conditions People Regulatory stability/instability (management/employees) within a country Product development Data storage and security ENVIRONMENTAL RISKS: FINANCIAL RISKS: Could be physical environmental risks or Associated with the financial business environment risks. PHYSICAL ENVIRONMENTAL RISKS: operations of a business. Flooding or droughts leading to problems Credit risk: debtors not paying with retaining raw materials. Fluctuations in the exchange rates Traffic in the area makes it difficult to reach a business. when importing and exporting Risk associated with a particular location, Interest rate increases e.g., high crime rates. Solvency risks BUSINESS ENVIRONMENT RISKS: Factors that could have a negative Socio-economic factors such as unemployment. impact on the cash flow of the Technological development leading to business, i.e., bad debt, investment obsolete equipment. in incorrect stock and expenses not Level of competition in the industry, correctly managed. potential new entrants or businesses offering substitute products. REPUTATIONAL RISKS: STRATEGIC RISKS: Damage to the business’s Strategic risks are risks that are reputation as a result of associated with the overall formulation and implementation business practice such as: of the strategy of the business. Customer complaints on This could include: social media A poorly formulated or Business causing communicated vision, mission, environmental damage and value statement. Business conducting business Unrealistic goals and an with other unethical unsuitable organization businesses structure could also present problems to the business. MANAGING RISKS It is important that risk management is seen as a holistic mechanism across various levels of management and all the business functions. Due to the integrated nature of operations and management decisions on all levels, it will impact the entire business. It is important that a business assesses the type of risk they are dealing with to understand the potential impact. Once the business has determined the potential impact of the risk, it has to develop strategies to deal with the risk. This is done by: Capitalizing on strengths Addressing weaknesses Exploiting competitor’s weaknesses Four steps in managing business risks: RISK MANAGEMENT Risk Assessment Risk Management Risk Response Risk Reporting Policy RISK ASSESSMENT Three steps: STEP 1: IDENTIFICATION OF THE RISK: Look at areas of uncertainty in business environments. During the process of risk identification, a methodical approach is important to ensure all significant activities in the business have been identified and all risks flowing from these activities are identified. A business may use a variety of methods to identify risks, these include:  RISK WORKSHOPS: STAKEHOLDER CONSULTATIONS: These workshops could be internal or If a third party has been identified as external being involved with a situation that may be a risk factor, information has to be obtained via a consultation. BENCHMARKING: SCENARIO PLANNING (WHAT IF): It may be useful to look at best practice Business simulations are handy tools to regarding certain risks in the industry look at “what if”, the possible outcome, and to plan how to handle the situation should it arise in the future. AUDITING: SURVEYS: Both internal and external auditors have A survey could assist the business in the responsibility to identify risks. There identifying risks by asking questions to could also be an audit to determine if the relevant internal/external parties. business dealt with the risk effectively. STEP 2: DESCRIPTION OF THE RISK: Once the risk factors have been identified, they need to be described in sufficient detail to ensure all relevant parties understand the risk issues and their origins. STEP 3: ESTIMATION OF THE IMPACT OF THE RISK: Helps the business to assess the impact of each risk. Assessing the impact of each riskPros factor, can be done by using tools such as: and Cons chart Cost/Risk ESTIMATION Benefit TOOLS Analysis Decision Trees PESTLE SWOT Once the risk factor's impact on the business has been estimated, it should be plotted on the Estimation Matrix. Low probability: Low impact These are the issues that the business is most likely to ignore because the chances of the event taking place are low, and even if it does happen the impact will not be serious. High probability: Low impact If the possible impact on the business is low, it may not be crucial to address the risk, even though the event’s probability is high. Low probability: High impact The events taking place’s chances are small but may have a big impact. The business will probably not invest major resources to prevent this risk but once it happens it will require immediate and serious attention from the business. High probability: High impact Although it may not be possible this is the risk that the business will try to avoid at all cost because the impact on the business will be serious.  ESTIMATION MATRIX High probability High probability Low impact High impact Low probability Low probability Low impact High impact RISK MANAGEMENT POLICY The second step of risk management is to ensure a comprehensive policy that is: Drafted (developed in writing) Communicated to all relevant parties Implemented in the business This will enable the business to respond to risks that have been identified and prioritized. RISK RESPONSE Third step in risk management. When referring to the estimation matrix risks can be: Avoided Reduced Accepted but carefully managed Choosing a suitable risk response involves developing a risk plan that considers all opportunity cost and consequences. It is important that the risk response is monitored on an ongoing basis to determine the effectiveness of the risk response and adapt to possible changes in level of risk. RISK AVOIDANCE: Action is taken to prevent or limit the activities leading to risk. This could include not entering into a specific geographical market. RISK REDUCTION: Action is taken to limit the possibility of the risk occurring and to mitigate the impact of the risk. This is usually done by implementing strict control mechanisms. RISK ACCEPTANCE: No action is taken to stop the risk or limit the impact. This may be because it will require more resources than what is seen as viable or when there is simply nothing that can be done as it is totally outside the scope of the control of the business. RISK REPORTING Fourth step in risk management involves reporting to relevant stakeholders. Two areas of risk reporting Reporting Reporting to internal to external stakeholde stakeholde rs rs  Reporting to internal Reporting to external stakeholders involves reporting stakeholders has increasingly risk management information been under the spotlight through Corporate Governance to people who are involved in efforts. decision-making or An example could be when BP performance reviews. had an oil spill and how the An example could be informing business is planning to resolve all internal stakeholders about this issue. Of course, it is only safety procedures in the prudent that the business business in case of possible provides details on how they risks (making the business will avoid the risk moving OHS- compliant). forward.