Practical Insights in Reducing and Managing Business Risks

Practical Guidelines in Managing Risks

• Understanding the nature of risk

• Identifying and prioritizing risks
• Considering the acceptable level of risk
• Understanding why risks become reality
• Applying a simple risk management process

Understand the Nature of Risk

Successful businessmen and decision-makers make sure that the risks resulting from their decisions are measured,
understood and as far as possible eliminated. They also go beyond the direct financial perspective and actively manage
risk as it affects the whole organization. Accepting that risks exist is a starting point for the other actions needed, but the
most important is to create the right climate for risk management. People need to understand why control systems are
needed; this requires communication and leadership skills so that standards and expectation are set and clearly understood.

Identify and Prioritize Risks

Identification of significant risks both within and outside the organization is crucial and allows to make informed
decisions. This makes it easier to avoid unnecessary surprises. Examples of significant risks might be the loss of a major
customer, the failure of a key supplier or the appearance of a significant competitor.

Consider the Acceptable Level Risk

The usual first step is to determine the nature and extent of the risks the business will accept (risk appetite). This involves
assessing the likelihood of risks becoming reality and the effect they would have if they did. Only when this is understood
can measures be taken to minimize the incidence and impact of such risks.

There is also an opportunity cost associated with risk: avoiding a risk may mean avoiding a potentially big opportunity.
People can be too cautious and risk averse even though they are often at their best when facing the pressure of risk
deciding to take a more audacious approach. Sometimes the greatest risk is to do nothing. 

Understand Why Risks Become Reality

The five most significant types of risk catalyst:

 • Technology. New hardware, software or system configurations can trigger risks, as can new demands on existing
information systems and technology. In early 2010, Metro Manila Development Authority Chair introduced a
congestion change for traffic using the center of the city; the greatest threat to the scheme’s success (and his
tenure as chair) was posed by the use of new technology. It worked and the scheme was widely seen as a success.
• Organizational change. Risks are triggered by, for example, new management structures or reporting lines, new
strategies and commercial agreements (including mergers, agency or distribution agreements).
• Processes. New products, markets and acquisitions all cause change and can trigger risks. The disastrous launch
of ’’New Coke" by Coca-Cola was an even bigger risk than anyone at the company had realized; it outraged
Americans who felt angry that an iconic US product was being changed. That Coca-Cola eventually turned the
situation to its advantage shows that risk can be managed and controlled, but such success is rare.
• People. Hiring new employees, losing key people, poor succession planning, or weak people management can al!
create dislocation, but the main danger is behavior: everything from laziness to fraud, exhaustion and simple
human error can trigger this risk.
• External factors. Changes to regulation and political, economic or social developments can all affect strategic
decisions by bringing to the surface risks that may have lain hidden. The economic disruption caused by the
sudden spread of the SARS epidemic from China to the rest of Asia in 2003 highlights this risk.

Apply Simple Risk Management Process

The stages of managing the enterprise-wide risk inherent in decisions are simple.

• First, assess and analyze the risks resulting from a decision by systematically identifying and quantifying them.
• Second, consider how best to avoid or mitigate them.
• Third, in parallel with the second stage, take action to manage control and monitor the risks.

Risk Management Process

A. Risk Assessment and Analysis

It is more difficult to assess the risks inherent in a business decision than to identify them. Risks that lead to
frequent losses, such as an increasing incidence of employee-related problems or difficulties with suppliers, can
often be solved using past experience. Unusual or infrequent losses are harder to quantify. Risks with little
likelihood of occurring in the next in the next five years are not important to a company focused on meeting
shareholders’ shorter-term expectations. Thus, it is sensible to quantify the potential consequences of identified
risks and then define courses of action to remove or mitigate them. Each category of risk can be mapped in
terms of both likely frequency and potential impact, with the potential consequences being ranked on a scale
ranging from inconvenient to catastrophic (see discussion on Risk Matrix and Mapping in the previous module).

B. Risk Management and Control

Risk should be actively managed and given a high priority across the whole organization. Risk management
procedures and techniques should be well documented, clearly communicated, regularly reviewed and
monitored. To successfully manage risks, you have to know what they are, what factors affect them and their
potential impact. If you plot the ability to control a risk against its potential impact, you can decide on actions
either to exercise greater control over the risk or to mitigate its potential impact. Risks falling into the top-right
quadrant require urgent action, but those in the bottom-right quadrant (total/significant control, major/critical
impact) should not be ignored because complacency, mistakes and a lack of control can turn the risk into a
reality.

Once the inherent risks in a decision are understood, the priority is to exercise control. All employees must be
aware that unnecessary risk taking is unacceptable. They should understand what the risks are, where they lie
and their role in controlling them. To achieve this, share information, prepare and communicate clear
guidelines, and establish control procedures and risk measurement systems.

C. Controlling and Monitoring Enterprise Wide Risk

The following questions when answered truthfully and positively will assist managers in deciding how to
manage the risks that confront the business enterprise.

• 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 are the potentially disclosing events that could inflict the greatest damage on your organization?
• What are the risks inherent in the organization’s strategic decisions, and what is the organization’s
ability to reduce their incidence and impact on the business
• 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?
• What review procedures are in place to monitor risks? 
• Are the risks inherent in strategic decisions (such as acquiring a new business, developing a new product
or entering a new market) adequately understood?
• At what level in the organization are the risks understood and actively managed?
• Do people fully realize the potential consequences of their actions, and are they equipped to understand,
avoid, control or mitigate risk?
• To what extent would be company be exposed if key staff left?
• If there have been major developments (such as a new management structure or reporting
arrangements), are the new responsibilities understood and accepted?
• Are management information systems keeping pace with demands? Are there persistent black spots -
priority areas where the system needs to be improved or overhauled?
• Do employees resent risk, or are they encouraged to view certain risks as opportunities?

Practical Considerations in Managing and Reducing Financial Risks

Finance is the lifeblood of a business, heavily influencing strategies and decisions at every level. Many managers find it
difficult to get to grips with financial issues and, as the 2008 global financial crisis revealed, many lost touch with basic
financial ground rules. Profitability, cash flow, long-term shareholder value and risk all need to be considered when
setting and reviewing strategy.

I. Improving Profitability
a. Variance Analysis

Interpreting the differences between actual and planned performance is crucial. Variance analysis is used
to monitor and manage the results of past decisions, assess the current situation and highlight solutions.

Common causes of variances include inefficiency, poor or flawed planning (for example, relying on
historically inaccurate information), poor communication, interdependence between departments and
random factors. Every business should use variance analysis but in a practical and pragmatic and cost-
effective way.

b. Assessment of Market Entry and Exit Barriers

How easy or difficult it is to either enter or leave a market is crucial in strategic decision-making. Entry
barriers include the need to compete with businesses that enjoy economies of scale or established
differentiated products.

Other barriers include capital requirements, access to distribution channels, factors independent of scale
(such as technology or location) and regulatory requirements. 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. Consider where the barriers to entry lie for your
market sector, how vulnerable you are to new entrants, and whether you can strengthen and entrench your
market position.
c. Break-Even Analysis

The break- even point is when sales cover costs, where neither a profit nor a loss is made. It is calculated
by dividing the costs of the project by the gross profit at specific dates, making sure to allow for overhead
costs. Break-even analysis (cost-volumeprofit or CVP analysis) is used to decide whether to continue
developing a product, alter the price, provide or adjust a discount, or change suppliers to reduce costs. It
also helps in managing the sales mix, cost structure and production capacity, as well as in forecasting and
budgeting.

d. Controlling Cost
 Focus on the big items of expenditures - Categories cost into major or peripheral items. Often, undue
emphasis is given to 80% of activities accounting for 20% of costs.
 Be cost aware - Casualness is the enemy of cost control. While focusing on major items of
expenditure it may also be possible to cut cost of peripheral items. Costs can be reduced over the
medium to long term by managers’ attitudes to cost control and the effects of expenses on cash flow.
 Maintain a balance between cost and quality - Getting the best value means achieving a balance
between the price paid and the quality received.
 Use budgets for dynamic financial management - Budge early so financial requirements are known as
soon as possible. Consider the best time-period for the budget – normally a year but it to rolling
budgets, getting managers to forecast the next 18 months every quarter. Budgets provide a starting
point for cash flow forecasts and revenue, and they also play an essential role in monitoring costs and
revenues.
  Develop a positive attitude to budgeting - People need to understand, accept and use the budget,
feeling sense of ownership and responsibility for developing, monitoring and controlling it.
 Eliminate waste - Japanese companies have directed much of their cost-management efforts towards
waste elimination. They achieve this by using techniques such as process analysis, mapping and re-
engineering.

Practical Techniques to Improve Profitability

Some practical techniques to improve profitability

 Focus decision-making on the most profitable areas. Concentrating on products and services with the best margin
will protect or enhance profitability. This might involve redirecting sales and advertising activities.
 Decide how to treat the least profitable products. This often drifts, with dwindling profitability. Turn around a
poor performer (by reducing costs, raising prices, altering discount or changing the product) or abandon it to
prevent drain on resources and reputation. The shelf-life and appeal of the product must be considered when
deciding to continue or discontinue it.
 Make sure new products enhance overall profitability. New product development often focuses on market need or
the production process, with insufficient regard to cost, price, sales volume and overall profitability, which are
inextricably linked.
 Manage development and production decisions. The amount spent on research, as well as priorities and methods
used, affect profitability. Too little expenditure may increase costs in the long-term
 Set the buying policy. For example, should there be a small number of preferred suppliers or a bidding system
among a wider number of potential suppliers? Also, consider techniques for controlling delivery charges,
monitoring exchanges rates, improving quality control, reducing inventory and improving production lead times.
 Consider how to create greater value from existing customers and products to enhance profitability. Ask:
o How can customer loyalty (and repeat purchasing) be enhanced?
o How can the sales proposition be made more competitive relative to the opposition?
o How can existing markets, sales channels, products, brand reputation and other resources be adapted to
exploit new markets and new opportunities?
o How can sales expenses be reduced? How can effectiveness of marketing activities be increased?
 Consider how to increase profitability by managing people. Successful leadership is prerequisite for profitability.
People need to be motivated and supported, and this implies rewarding them fairly for their work, training and
developing them, providing clear sense of direction, and focusing on the needs of the team, the task and the
individual.

II. Avoiding Pitfalls

Many managers needs have financial responsibilities and their decisions will often be influenced by or have an impact on
other parts of the business. The following principles will help avoid flawed financial decision-making.

 Financial expertise must be widely available

- Every manager needs to understand why successful financial management increases profits, people need
to own their part of the financial control process, to have the information and expertise needed to
routinely make the best financial decisions.
 Consider the impact of financial decisions
- Do not ignore or underestimate the wider impact of finance issues upon other departments and decisions.
 Avoid weak budgetary control
- Budgets are an active tool to help make financial decisions, not merely a way to measure performance.
 Understand the impact of cash flow
- Non-financial managers often ignore cash flows and the time value of money. Everyone should be aware
of the importance of cash to the organization.
 Know where the risk lies
- Identifying risks and how to reduce them is crucial to successful financial decision-making. For example,
managers needto know not only where the break-even point is, but also how and when it will be reached.