Risk and risk exposure

The nature of risk

Risks from which either

good or harm may result:

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Risks that affect society in • Downside - damaging
general and are beyond effect
the control of any one • Upside - result better
individual than expected

Fundamental risks Particular risks Speculative risks Pure risks

01 03
Risks over which an Risks whose only possible
individual may have some outcome is harmful
measure of control

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Categories of risk
Risks

Strategic Operational

Introduction (purpose, Information

Business and IT
status and contents) Non-business

Compliance
Product Financial

Wastage

Environmental Event
Reputation
and ethics

Stakeholder
Fraud

Investment Health and

safety

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Institute of Risk Management (IRM)

Risk categorisation serves the following

purposes:

Identifying risks that are interrelated

Encouraging a systematic approach

integral to an enterprise risk
management system

Assign responsibility for managing risks

and to design controls to combat them

Assisting management review and

reporting of risk

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Risk drivers
Externally driven

Financial risks Strategic risks

Interest rates Competition
Foreign exchange Customer changes
Credit M&A Industry changes
integration Customer demand
Research and
Liquidity and development
cash flow Intellectual capital

Internally driven

Accounting controls Public access

Information systems Employees
Recruitment Properties Hazard risks
Operational risks Supply Products and Contracts
Regulations Chain services Natural events
Culture Suppliers
Board composition environment

Externally driven
Risk drivers
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Strategic risks

Strategic risk: The potential volatility of performance over the longer term
caused by an organisation’s decisions and events.

They relate to the organisation’s longer-term place in, and relations with, the
outside environment

Factors influencing strategic risks:

• Industries/markets where business operate • Level of operating gearing
• State of economy • Flexibility of production process
• Competitors and M&A • R&D capacity
• Product’s life cycle • New technologies
• Input prices

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Strategic risks

Market risk Reputation and ethics

Currency risk Information risks

Interest rate risk Financial risks

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Operational risks
• Operational risks are usually those that could go wrong on a
day-to-day basis, and are not generally relevant to the key
strategic decisions that affect a business.

• Operational risks include:

Operational risks:
The risk of loss from a
failure of internal
business and control
processes; sometimes
referred to as process risk
• Losses from internal control system or audit inadequacies
• Non-compliance with regulations or internal procedures
• Information technology failures
• Human error
• Loss of key person risk
• Fraud
• Business interruptions

• Hazards are possible sources of a danger and can be

categorized as natural or human-caused hazards.

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Risks in international business
The degree to which the
value of the firm’s future cash
flows can be influenced in
the medium to long term by
foreign exchange
movements
The risk of change in the financial
position of the company due to
exchange rate changes which
usually arises when financial
statements are translated to other
than domestic currency
The risk that a transaction in
a foreign currency is
recorded at one rate and
then settled at a different
rate
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Risks in international business

Physical risk – goods lost or

The risk caused by The risk that arises in
government action, which
attempt to transplant a
can render assets worthless
successful business model
or alter the ability to from one market to another
expatriate cash
due to different customs,
tastes, laws and language
stolen in transit
Credit risk – payment default
by customers
Liquidity risk – inability to
finance an increased
working capital cycle

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Understanding and assessing the scale of risk

Assessing the volatility of
future cash flows by
attaching a value to the
various risk factors and
calculating their impact.
Changes are made to
Expected value of loss = significant variables in
Probability of loss × Impact order to determine the
(size of potential loss) effect of these changes
on the planned outcome.
Offsetting risks that are
negatively correlated to
balance their impact and
likelihood regardless of the
circumstances.

Regression Expected Sensitivity Diversification

values analysis of risks

Simulation and Accounting Risk

scenario planning ratios mapping

Identifying possible future
situations and determining
the best ways in which
these can be controlled or
managed.
Use of different ratios to
evaluate the riskiness of an
organisation’s operations.
A typical risk map is a chart
with one axis for severity or
impact of loss and the
other axis for frequency or
likelihood of loss.

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Accounting ratios used in risk assessment
𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡
Debt ratio = X 100%
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡
Gearing= X 100%
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝑒𝑞𝑢𝑖𝑡𝑦+𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡

𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥

Interest cover=
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑐ℎ𝑎𝑟𝑔𝑒𝑠

𝑁𝑒𝑡 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤

Cash flow ratio=
𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
Current ratio=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑙𝑒𝑠𝑠 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

Quick ratio=
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

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Interpreting ratios for signs of danger

Changes in revenues

Changes in costs

Increases in receivables or inventories

Increase in short-term payables (creditors)

Loan finance that has to be repaid

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Risk mapping and acceptability of risks

• Risk profile is drawn as a chart or graph with

one axis for severity or impact of loss and the
other axis for frequency or likelihood of loss

• Risk management approach varies according

to the position of each risk on the map: risk in
darker sections require more prioritization.

• Acceptability of risks-pragmatic approach:

trading off cost and benefit by implementing
controls appropriate to the level of risk faced.
ALARP – ‘as low as reasonably practicable’.

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Diversification of risks

Correlated risks: Two risks that vary together. If positive correlation

exists, the risks will increase or decrease together. If negative
correlation exists, one risk will increase as the other decreases and
vice versa

Related risks: Risks that are connected because the causes of

the risk are the same.

Diversification: Offsetting risks that are negatively correlated to

balance their impact and likelihood regardless of the
circumstances (sometimes called a ‘portfolio’ approach).

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