CHAPTER 12

PRACTICAL GUIDELINES IN REDUCING AND MANAGING BUSINESS RISKS

 Apply the principles and techniques appropriate to the situation.

 Risks can be managed and controlled but success is rare. Hence, the need for proper and
careful risk management.

UNDERSTAND THE NATURE OF RISK

 Some companies view risk as an opportunity.

 Starting point: Accept that risks exist.
 Understanding the nature of risk involves assessing the likelihood of risks becoming reality
and the effect they would have if they did.

IDENTIFY AND PRIORITIZE RISKS

 Identify significant risks both within and outside the organization in order to avoid
unnecessary surprises.
 Examples of significant risks: loss of a major customer, failure of a key supplier,
appearance of a significant competitor
 People behave differently and inconsistently when making decisions involving risk.
 For a more structured analysis, define the categories into which risks fall.

TYPICAL AREAS OF ORGANIZATIONAL RISK

1. Financial – inefficient cash management, fraud

2. Commercial – poor brand management, market changes
3. Strategic – marketing and pricing decisions, resource allocation decisions
4. Technical – failure of plant or equipment, accidental or negligent actions
5. Operational – product or design failure, corporate malpractice

CONSIDER THE ACCEPTABLE LEVEL OF RISKS

 Opportunity cost associated with risk: Avoiding a risk may mean avoiding a potentially
big opportunity.
 Sometimes, the greatest risk is to do nothing.

UNDERSTAND WHY RISKS BECOME REALITY

 Upon identification of risks, they can be ranked according to their potential impact and the
likelihood of their occurrence in order to highlight

JENIELYN P. TORRES, CPA 1

 a. where things might go wrong and what their impact would be
b. how, why, and where the risk catalysts might be triggered

TYPES OF RISK CATALYSTS (those that can change and trigger risks)
1. Technology – new hardware, software or system configurations; traffic congestion change
introduced by the Metro Manila Development Authority (MMDA) Chair
2. Organizational change – new management structures or reporting lines, new strategies,
commercial agreements like mergers
3. Processes – new products, markets, and acquisitions
4. People – hiring new employees, poor succession planning, weak people management,
behavior - laziness, fraud, human error
5. External factors – changes in regulation and political, economic, or social developments;
economic disruption brought by the pandemic

APPLY A SIMPLE RISK MANAGEMENT PROCESS

A. Risk Assessment and Analysis

 Assessment of risk differs from one company to another. For example, there are risks that
can be solved using past experience. There are also those that are harder to assess or
quantify. When a company is focused on meeting short-term expectations, risks with little
likelihood of occurrence in the next five years may not be so important to such company.

B. Risk Management and Control

 Risk management procedures and techniques should be well documented, clearly

communicated, and regularly reviewed and monitored.

Table 1. Assessing and Mapping Risk

JENIELYN P. TORRES, CPA 2

 - Risks falling into the top-right quadrant require urgent action.
- Those in the bottom-right quadrant should not be ignored because complacency,
mistakes, and lack of control can turn into a reality.

 Once the inherent risks in a decision are understood, the priority is to exercise control.

 Share information, prepare and communicate clear guidelines, and establish control
procedures and risk measurement systems.

Avoid and Mitigate Risks

 Reduce or eliminate those that result only in costs.

 Can be achieved through quality assurance programs, environmental control processes,

health and safety regulations, accident prevention and emergency equipment installation,
and security measures to prevent crime, sabotage, espionage and threats to people and
systems

 Can also be reduced or mitigated by sharing them – ex: acceptable service agreements from
vendors

Create a Positive Climate for Managing Risk

 The ethos of an organization should recognize and reward behavior that manages risk.

Overcome the Fear of Risk

 Taking risks is needed to keep ahead of the competition.

 See risk as an opportunity, not a threat.
 Risk is both desirable and necessary. It provides opportunities to learn and develop and it
compels people to improve and effectively meet the challenge of change.

C. Controlling and Monitoring Enterprise-Wide Risks

Guide Questions

- Where are the greatest areas of risk relating to the most significant strategic decisions?
- What level of risk is acceptable for the company to bear?
- What is the overall level of exposure to risk? Has this been assessed and is it being
actively monitored?
- What are the costs and benefits of operating effective risk management controls?

JENIELYN P. TORRES, CPA 3

 - Do employees resent risk, or are they encouraged to view certain risks as opportunities?

PRACTICAL CONSIDERATIONS IN MANAGING AND REDUCING FINANCIAL

RISKS

Finance – lifeblood of a business. It heavily influences strategies and decisions at every level.

1. Improving Profitability

A. Variance Analysis – interpreting the differences between actual and planned

performance

B. Assessment of Market Entry and Exit Barriers – assessment of how easy or difficult it
is to either enter or leave a market

 When markets are difficult or costly for competitors to enter and relatively easy and
affordable to leave, firms can achieve high, stable returns, while still being able to leave
for other opportunities.

C. Break-even Analysis – cost-volume-profit analysis; analysis of the point when sales

cover costs or where neither profit nor loss is made

D. Controlling Costs – achieved by focusing on the big items of expenditure, being aware
of costs, maintaining a balance between costs and quality, using budgets for dynamic
financial management, developing a positive attitude to budgeting, eliminating waste

Practical Techniques to Improve Profitability

- Focus decision-making on the most profitable areas.

- Decide how to treat the least profitable products.
- Make sure new products enhance overall profitability.
- Manage development and production decisions.
- Set the buying policy.
- Consider how to create greater value from existing customers and products to
enhance profitability.
- Consider how to increase profitability by managing people.

2. Avoiding Pitfalls in Making Financial Decisions – achieved by applying the following

principles

a. Financial expertise must be widely available.

- To routinely make the best financial decisions

b. Consider the impact of financial decisions.

JENIELYN P. TORRES, CPA 4

 - Impact of finance issues upon other departments and decisions

c. Avoid weak budgetary control.

- Budgets are useful not just in measuring performance but also in making financial
decisions.

d. Understand the impact of cash flow.

- Importance of cash in organizations

e. Know where the risk lies.

- Ex: not only where the break-even point is but also how and when it will be reached

3. Reducing Financial Risk

Guide Questions
- Are the most effective and relevant performance measures in place to monitor and
assess the effectiveness of financial decisions?
- Is there a positive attitude to budgets and budgeting?
- What are the least profitable parts of the organization? How will they improve?
- How efficiently is cash managed? Do your strategic business decisions take account of
cash considerations, such as time value of money?

JENIELYN P. TORRES, CPA 5