LESSON

7 RISK MANAGEMENT

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TOPICS
 Overview of Risk Management Planning
 Steps in Risk Management Planning
 Managing Production Risk
 Managing Marketing Risk
 Managing Financial Risk
 Managing Human Risk
 COSO’s Enterprise Risk Management Framework

LEARNING After studying this chapter, you should:

OUTCOMES

 Be familiar with the risks associated with business operations.

 Be acquainted with terminologies that are employed throughout the discussion.
 Understand production, marketing, financial, and human risks.
 Possess a conceptual appreciation of the ECG Frameworks.

Introduction

Risk can be defined as the chance of loss or an unfavorable outcome

associated with an action. Uncertainty is not knowing what will happen in the future.
The greater the uncertainty, the greater the risk. Since risk may arise from different
business transactions, it is essential to note and plan the risk management program of
the organization. A need for risk management for a large organization would minimize
the likelihood of risk. However, the role of risk managers in a small entity may be
oversee by the owner itself.
Risk management involves optimizing expected returns subject to the risks involved
and risk tolerance. Risk may arise from production to management of human
resources.

There are businesses that are risky in nature who are confronted with risky
environment every day. The consequences of their decisions are generally not known
when the decisions are made. Furthermore, the outcome may be better or worse than
expected.

Steps in Risk Management Planning

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IDENTIFY RISKS

The first step in the process of managing risk is recognizing and classifying the prospective risks.
Risk may arise from production, marketing, financial, legal and human activities.

HUMAN

FINANCIAL
LEGAL

PRODUCTION

MARKETING

1. PRODUCTION RISK

Manufacturing companies are confronted with production risk. Any production related
activity or event that has a range of possible outcomes is a production risk. The major
sources of production risks are supplies, availability of raw materials, direct labor, and
even fortuitous event such as fire, rain, flood, earthquake and the like.

2. MARKETING RISK
All businesses need to market its product making the marketing risks be part of the
everyday activities. There are company who have found stable place in the industry but
it doesn’t mean that they have not encountered risk. The more the company enters the
global market, the greater the chance that may encounter marketing risk.
Unanticipated forces anywhere in the world, such as weather or government action, can
lead to dramatic changes in output and input prices. When these forces are understood,
they can become important considerations for the skilled marketer. Marketing risk is
any market related activity or event that leads to the inconsistency of prices receive for
their products or pay for production inputs. Access to markets is also a marketing risk.

3. FINANCIAL RISK

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Financial risk encompasses those risks that threaten the financial status of the business
and has four basic components:

The cost and The ability to meet The ability to The ability to
availability of cash flow needs in maintain and grow absorb short-term
capital a timely manner equity financial shocks

Though all the sources of risks that were identified can greatly affect the business,
financial risk should be given top priority. Capital is the life blood of the business. Thus,
without capital, investments, cash flow, or any other economic activities, the business
could no longer be in its operations.

4. LEGAL RISK
The business should not only focus on the nature of the business alone. Since there are
actors that could greatly affect the operations, aside from the internal forces, there are
also legal risk. Legal risk may be encountered when business involves commitment that
have legal implications. Acquiring loans to bank is an example. For example, acquiring an
operating loan has legal implications if not repaid in the specified manner. Production
activities involving the use of harmful substance have legal implications if appropriate
safety precautions are not taken. Marketing of products can comprise contract law.
Human issues associated with agriculture also have legal implications, ranging from
employer/employee rules and regulations, to inheritance laws. The legal issues most
commonly associated with agriculture fall into five broad categories:

The ability to
Contractual Business Public policy and
maintain and grow Tort liability
arrangements organization attitudes
equity

5. HUMAN RISK
People are both a foundation of business risk and a significant part of the strategy for
dealing with risk. At its core, human risk management is the ability to keep all people
who are involved in the business safe, satisfied and productive. Human risk can be
summarized into four main categories:

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  Human health status;
 Family and business relationships;
 Employee management;
 Transition planning.

RISKS:
Production
Marketing
Financial
Legal
Human

MEASURE RISKS

One way of measuring risk is the probability method. Probabilities are simply
a way of stating the chance of various outcomes that will likely to occur. Weather
forecasts use probabilities. For example, they may indicate a 20 percent chance of rain
or a 40 percent chance of snow. Some probabilities are known objectively by
observation or measurement. Some probabilities must be subjectively estimated by the
decision maker.

ASSESS RISK BEARING CAPACITY

Individual’s capacity or ability to bear (or to take) risk may also affect s the risk
management strategies of the organization. Financially, risk bearing capacity is directly
related to the solvency and liquidity of one’s financial position.
Risk bearing ability is also affected by cash flow requirements. The obligations for cash
costs, taxes, loan repayment, and family living expenses that must be met each year are
its examples. The level of obligations determine the percentage of total cash flow. Thus,
the higher the obligations the less able the business is to assume the risk

EVALUATE RISK TOLERANCE OR PREFERENCES

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Individuals may be categorized into one of three wide sorts of risk tolerance. Risk averse
producers are the most cautious risk takers. They are willing to allow deductions of
income to some deductions of risk. They may esteem security, solidness, or money
related survival more than an opportunity for higher benefits.
The degree of risks varies according to situations so that neutral risk producers should
recognize it. Before making a decision or taking action they gather information and
analyze the odds and seek to maximize income Risk preferring individuals may look at
risk as a challenge and interesting activity to work with.

SET RISK MANAGEMENT GOALS

Goal should be specific, measurable, attainable, realistic, and time bound. If one
achieves all conditions of a specific measurable goal, confidence boost and satisfaction
will be achieved. If a measurable goal is not attained, strategies of the organization must
be identified and adjustments can be made to improve the likelihood of success.
Care should be taken to set goals over areas where one has as much control as possible.
Nothing is as discouraging and counterproductive to goal setting as failing to achieve a
goal for reasons beyond your control. If goals are set on performance or skills to be
acquired, then control over achievement is maintained.
There are beneficial reasons to set goals:

To reflect the values, To set priorities for the

interests, resources and
capabilities of everyone
allocation of scarce
involved in the business resources

To provide a basis for

all business and To measure progress
family decisions

END 16noV

IDENTIFY EFFECTIVE RISK MANAGEMENT TOOLS

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It is necessary for an effective risk management to integrate a well-structure strategies
and policies because risk may arise from different sources. The particular combination
used by a risk managers will depend on the individual’s situation, the types of risk faced,
and the risk attitudes or preferences. Some risk responses such as vaccinations,
preventative maintenance, inventories, and irrigation act primarily to reduce the chance
that an adverse event such as disease, breakdown, and drought will occur.

SELECT PROFESSIONAL ASSISTANCE

Despite the fact that risk management is challenging, there are many
professional resources available that offer different professional services. Extension
educators and university extension specialists are trained to provide educational
programs and leadership to help implement the planning process. Insurance agents,
crop and livestock consultants, livestock nutritionists, marketing specialists, lenders,
attorneys and others are available and well qualified to help with risk management
planning, depending upon the specific need. The assistance of the professions will
greatly help to lessen or prevent risk in the organization.

MAKE A DECISION AND IMPLEMENT THE PLAN

Implementing the plan is probably the most difficult aspect of any decision process.
Following through the steps provides the confidence and numerical measurements to
implement a plan that best fits the situation. Also, decision should be sound because the
success of the organization lies on the decision made on to continue the operation
despite of the risks being encountered.

EVALUATE THE RESULTS

Once the decisions have been rendered. The last phase would be the evaluation.
Evaluation involves the measurement of desired outcome over the actual outcome. So it
is of utmost important that organizations have benchmark of the desired result.

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MANAGING PRODUCTION RISK

Any production related activity or event that is uncertain is a production risk.

Variability in outcomes from those expected creates risks to your ability to achieve
financial goals.
Organizations have three choices in dealing successfully with production risks.

They can control or minimize risk through

management practices by doing a better job of
what they currently do.

They can reduce production variability by making

changes such as diversifying, integrating, applying
new technology, etc.

They can transfer production risk to someone else

through contracting, purchasing insurance, etc.

1 CONTROL OR MINIMIZE RISK

There are several examples of how risk can be minimized or controlled through improved
management practices. The key to success in the organization is definitely the timeliness of
operations which has a large impact in the business operations.

Involving preventative maintenance is also a method of managing production risks by

minimizing the likelihood of negative events taking place. Many risks are hard to anticipate. The
use of basic control and feedback strategies is important.

2 REDUCE VARIABILITY

DIVERSIFICATION

Diversification is an effective tool of

decreasing income unpredictability. When

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low income from one enterprise is offset by satisfactory or high incomes from other
enterprises this is where effective diversification occurs. It typically lessens large year-
to-year variations in income and may ensure adequate cash flow for meeting production
costs, debt obligations, and family living needs.

The benefits of diversifying income sources depend on the variability of returns faced by
a producer. Diversification to help counter negative fluctuations in income can also be
achieved by having several income sources, such as additional products, investment and
savings.
INTEGRATION

All of the ways that output from one stage of

production is transferred to another is what
integration comprises. For example, a nursery
that provides landscaping services using their
own nursery stock is vertically integrated.
Integration is important because it adds value
in the product or services that could greatly
affect the organization.

APPLY TECHNOLOGY

In a competitive market, the application of technology is also a part of everyday business

activity. There are new technologies that can help the company in managing risks be it from
different sources. However, the technology has greater applicability when it comes to
production risks. One takes advantage of advances in computers and mechanical engineering to
make better, more efficient, machines and equipment.

The key to applying technology in managing risk is to do so in a way that lowers total risk.
Sometimes new technology may increase risk, or the increased cost for the corresponding
reduction in risk is prohibitive.

3 TRANSFER RISK TO SOMEONE ELSE

A contract is usually defined as a meeting of the mind or oral agreement between two
or more parties who bind themselves in a commitment to do or refrain from doing
something. In business, contracts between outside and internal forces specify certain
conditions associated with producing and/or marketing a product. By combining

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different market functions, contracting generally reduces participants’ exposure to risk.
In addition to specifying certain quality requirements, contracts also can specify price,
quantities to be produced, and services to be rendered.

CONTRACTING

Production contracts can take many forms,

depending based on the commodities being income
contracted and the economic needs of the stability
parties entering into the contract. Generally,
producers give up some management
independence and decision making for a more market improved
stable income and less variability. security efficiency

INSURANCE

By definition (Crane, 2012), insurance is the

means of protecting against unexpected loss. access to
capital
The risk can be passed off by purchasing
insurance from an insurance company, or it can
be self-insured. With self-insurance there are no premiums to pay, but in the event of a
loss, the operator bears the full amount of the loss.
The three types of insurance that all operators should carry are:
 Property and casualty insurance;
 Health, life, and disability insurance;
 Liability insurance.
Managing Marketing Risk
In dealing with marketing risk, it is essential to understand how markets function, how
prices are determined and the tools that are available to take advantage of
opportunities.
MARKETING PLANS
A marketing plan sets specific actions to be taken and the steps needed to accomplish
the business goals. It requires:

An understanding of the
alternatives and the
tools the business wishes The discipline to follow
to use through.

Analysis of 10
the
alternatives
THE COMPONENTS OF MARKETING DECISIONS
There are six basic decisions with each marketing action. These are (Crane, 2012):
1. When to price or sell. This decision requires determining the time when the
price will be established. This could be at delivery or at another time.
2. Where to price or sell. Typically there are a number of alternatives, some
through direct selling and some through contracting.
3. What form, grade or quality to sell. Some commodities are more sensitive to
quality factors than others while other commodities may not have established
quality standards.
4. How to price. This involves choosing among various alternative tools or
mechanisms to set the price.
5. What services to use. There may be specific services offered by agribusiness
associates.

ADDITIONAL PERSONAL FACTORS

There are two other personal factors which will assist in establishing and following
through with the marketing plan (Crane, 2012)::
1) Assess your risk tolerance. The inability to control and predict market forces creates
anxiety. Being open about your comfort level with risk helps establish the marketing plan that
fits your situation and hence, reinforces the discipline to carry it out.

2) Upgrade your marketing skills. This should be an ongoing process. The structure of
markets and the factors affecting them is constantly changing. There are also new skills to learn
and update. There are a variety of sources to help with these efforts including direct interaction
with educators, commodity brokers, grain dealers and consultants.

Managing Financial Risk

Financial risks include those risks that threaten the financial health and stability of the
business. The basic components of financial risk are:

COMPONENTS

The ability to meet cash flow needs

The cost and availability of debt capital
and commitments in a timely manner

Absorb short term financial shocks Maintain and grow the equity in the business.

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FINANCIAL STATEMENTS
To address the major elements of financial risk itemized at the start of this lesson, a
good set of financial records is necessary. These records deliver the flow of information
needed to evaluate past performance and plan future strategies through a set of specific
financial statements.
Financial statements provide the foundation to oversee the financial position,
control expenses, and measure various aspects of the financial performance of
the business. The essential financial statements are the balance sheet, statement
of owner’s equity, income statement and cash flow statement.

 BALANCE SHEET - The balance sheet or net worth statement is a picture of the
financial position of a business. It shows the worth of all assets which is
“balanced” between the values of all liabilities and owners’ equity.
 INCOME STATEMENT - The income statement, or profit and loss statement,
shows the net income for the business during the accounting period after
deducting all the expenses throughout the operations of the business.
 STATEMENT OF OWNER’S EQUITY - The equity position over time measures the
financial growth and progress of the business. Changes can occur due to retained
earnings, withdrawals and contributions, changes in the market value of assets
or changes in personal net worth from sources.

 CASH FLOW STATEMENT- This statement provides overview of the three

activities namely; operating, investing, and financing activities of the business.
This shows how these activities affect the business and the flow of cash in the
organization.

ASSESSING AND MANAGING FINANCIAL RISKS USING FINANCIAL PERFORMANCE

MEASURES

REPAYMENT
LIQUIDITY SOLVENCY PROFITABILITY
CAPACITY

Managing Human Risk

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Human risks are those risks associated with the people involved in the business. This
refers to the risks or uncertainty related to the human participations that are important
for business success. Human risks can be summarized into four main categories (Crane,
2012):

ST
A 1) Human health and well-being;
RT 2) Family and business relationships;
3) Employee management; and,
4) Transition planning.

What are ESG-related risks?

ESG-related risks are the environmental, social and
governance-related risks and/or opportunities that may impact an entity. There
is no universal or agreed-upon definition of ESG-related risks, which may also be
referred to as sustainability, non-financial or extra-financial risks.

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*The discussion below was lifted from the Commission of Sponsoring Organization
designed guideline and principle.*

Why do

Environmental, Social and Governance-related risks matter for

organizations?
ESG-related risks are not necessarily new. In particular, corporations, organizations,
governments and investors have been considering governance risks for many years,
focusing on aspects such as financial accounting and reporting practices, the role of
board leadership and composition, anti-bribery and corruption, business ethics, and
executive compensation.
However, over the last several decades – and particularly the last 10 years – the
prevalence of ESG-related risks has accelerated rapidly. In addition to a clear rise in the
number of environmental and social issues that entities now need to consider, the
internal oversight, governance and culture for managing these risks also require greater
focus.
Figure 1 outlines the growing pace with which other organizations have failed to
manage ESG issues, leading to impacts on reputation, customer loyalty and financial
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performance. In many cases, the media, social media and other non-governmental
organization campaigns play a role in bringing these issues to the attention of civil
society and the organization.

When incidents related to pollution, customer and employee safety, ethics and management
oversight have such dramatic impacts on market prices, it becomes clear that ESG issues are
business issues and that their near-term market impacts reflect anticipated long-term effects on
cash flows and associated risks.

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The purpose of this guidance is to help an entity achieve:

• Enhanced resilience: An entity’s medium- and long-term viability and resilience will depend on
the ability to anticipate and respond to a complex and interconnected array of risks that
threaten the strategy and objectives.

• A common language for articulating ESG-related risks: ERM identifies and assesses risks for
potential impact to the strategy and business objectives. Articulating ESG-related risks in these
terms brings ESG issues into mainstream processes and evaluations.

• Improved resource deployment: Obtaining robust information on ESG-related risks enables

management to assess overall resource needs and helps optimize resource allocation.

• Enhanced pursuit of ESG-related opportunities: By considering both positive and negative

aspects of ESG-related risks, management can identify ESG trends that lead to new
opportunities. • Realized efficiencies of scale: Managing ESG-related risks centrally and
alongside other entity-level risks helps to eliminate redundancies and better allocate resources
to address the entity’s top risks.

• Improved disclosure: Improving management’s understanding of ESG-related risks can provide

the transparency and disclosure investors expect and achieve compliance with jurisdictional
reporting requirements.

1. Governance and culture for ESG-related risks

Governance is the systems and processes that ensure the overall effectiveness of an entity –
whether a business, government or multilateral institution. Effective governance provides the
oversight, structure and culture needed to establish the goals of the organization, the means to
pursue them and the ability to understand any associated risks.

Oversight and governance for ESG

Each organization has its own approach to oversight and governance. The King IV Report
on Corporate Governance for South Africa (King IV report), published in 2016, provides
one perspective on what defines good governance in the context of ESG-related
business and societal changes, such as inequality, climate change, radical transparency
and rapid technological and scientific advancements. The King IV report offers a
principles-based approach to ethical and effective leadership by the governing body in
pursuit of defined outcomes that include an ethical culture, good performance, effective
control and legitimacy. Some of the King IV report recommendations that can help
support ESG-related risk governance include:
 Establishing a social and ethics committee as a prescribed board committee.
 Emphasizing the critical role of stakeholders in the governance process. The
board should consider the legitimate and reasonable needs, interests and
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 expectations of stakeholders, while recognizing the role of stakeholders to hold
the board and the company accountable for their actions and disclosures.
 Having a strong focus on opportunity management as well as risk management –
so task the risk committee with identifying opportunities linked to certain risks.
 Requiring the board to pay specific attention to opportunities in the strategic
planning process.

2. Strategy and objective-setting for ESG-related risks

Maintaining a strong understanding of the entity’s strategy, objectives and business
context is critical to ERM. When identifying, assessing or managing ESG-related risks,
risk management and sustainability practitioners should work to gain a holistic view of
the internal and external environment, as well as how possible events and trends may
impact the entity’s strategy, business objectives and performance. Global trends, such
as globalization, rapid advances in technology, changes to the natural environment,
demographic shifts and geopolitical influences,1 have caused the business context for
many entities to become more complex and interconnected. Entities employ specialists,
such as sustainability practitioners, to monitor global megatrends and to understand
how these trends translate to ESG issues for their organization. Risk management
practitioners and risk owners can leverage this understanding to support a more holistic
view of the entity’s risk profile.
3. Performance for ESG-related risks
Performance focuses on practices that support the organization to make decisions in the pursuit
of its strategy and objectives.

 Identifies risk: The organization identifies risk that impacts the performance of
strategy and business objectives.
 Assesses severity of risk: The organization assesses the severity of risk.
 Prioritizes risks: The organization prioritizes risks as a basis for selecting
responses to risks.
 Implements risk responses: The organization identifies and selects risk
responses.
 Develops portfolio view: The organization develops and evaluates a portfolio
view of risk.

Review and revision for ESG-related risks

ERM, however, is not a “one and done” activity. It is a dynamic process that requires
ongoing review and revision of both individual risks and the ERM process overall. In many
jurisdictions, monitoring the effectiveness of an entity’s internal control and risk
management process is required by regulation. For example, Norway’s financial sector
regulation on risk management requires the CEO to “continuously monitor changes in the

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entity’s risks and ensure that the firm’s risks are properly addressed in accordance with the
board’s guidelines.”

Information, communication and reporting for ESG-related risks

This chapter relates to the COSO ERM Framework component on Information,

communication and reporting and the three associated principles:2 18 Leverages
information technology: The organization leverages the entity’s information and technology
systems to support enterprise risk management. 19 Communicates risk information: The
organization uses communication channels to support enterprise risk management. 20
Reports on risk, culture and performance: The organization reports on risk, culture and
performance at multiple levels and across the entity. The primary aim of internal
communication and reporting is to provide decision-useful information on an entity’s risk
management approach and performance. Internal communication and reporting can
enhance awareness of ESG-related risks to the appropriate level of the entity, communicate
how well the risks are being managed and provide information to support better decision-
making across the entity. External communication and reporting on risk management are
regulatory requirements in many jurisdictions, requiring entities to report on the risk
management process and disclose key risks to a selection of defined stakeholders. An
increase in demand for ESG-related information from investors is also driving organizations
to voluntarily disclose ESG-related information publicly.

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Activity 1
Substantiate the phrase below.

Risk is what makes it possible to make a profit. If there was no risk,

there would be no return to the ability to successfully manage it.

Activity 2
You have been going to school in the same building for the past five years. Over
time you have noticed that more and more students are coming to class with inhalers in
case they have an asthma attack. You begin to wonder if this trend is connected to
something in the school environment.
Question:
How would you begin to assess whether or not there is a possible relationship between
spending time in your school building and having asthma?

Activity 3

After you finished washing the dishes last night, you noticed that you couldn’t
turn the water completely off and that there was a steady drip coming from the faucet.
You intended to inform your parents but forgot to do so before going to bed, as well as
before leaving the house this morning for your week-long family vacation. The more you
think about it, the more you wonder if the sink will overflow before you return from
your trip.
Question:
How would you assess the probability that the leaky faucet will result in the sink
overflowing and flooding the kitchen?

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Activity 4

Using your knowledge in risk management, create a checklist for managing a financial
risk.
Consider the checklist below as a guide.

OVERALL RISK MANAGEMENT PLAN CHECKLIST:

 Have the primary sources of risk been identified and classified?
 Have the risk outcomes and their likelihood or probability of occurring been estimated?
 Has the financial capacity of the business or ability to bear risk been evaluated?
 Have the risk tolerances of the business operators been considered?
 Are risk goals written and are they specific, measurable, attainable, relevant, and timed?
 Have the goals been shared with everyone involved in the business?
 Have risk tools and strategies been identified to help manage risks which could prevent
achieving established goals?
 Has a confident relationship been established with a team of risk management advisors,
so they can help assess and manage business and personal risk exposure?

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REFERENCES
Book:

Galanza, Raquel M. (2015). Auditing Assurance Principles, Professional Ethics, and Good
Governance. Rex Printing Company, Inc.

Roa, Floriano C. (2012). Business Ethics and Social Responsibility. Rex Book Store

Salosagcol, et. al., (2014). Auditing Theory. GIC Enterprises & CO., INC.

Internet:

Commission of Sponsoring Organization (2018). Enterprise Risk Management. Retrieve

July 20, 2020 from https://www. google.com/search?q =
enterprise+risk+management+pdf
=1C1GIGM_enPH888PH888&oq=en&aqs=chrome.0.69i59l3j69i57j69i6
0j69i65j69i60l2.7502j0j4&sourceid=chrome&ie=UTF-8

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