Business is about creation and exchange of values. What we are buying and what everyone is selling to us is the promise of “security.”
The tem risk’ refers to uncertainty. Business organisations operate within a dynamic busines environment; hence they are exposed to a variety of risks. A business risk is a possibility of incurring a loss.
Risk management is the avoiding or minimising of potential losses with the objective to ensure continuity of profitable operation. To avoid losses, attempt should be made to identify possible sources of loss and consider methods of coping with these possible losses.
Identifying Risk
There are no clear cut ways of identifying risks. The first thing a company needs to do in risk management system is to understand what risk it faces in its environment (strategic risk) and internally (operational risks). Havíng identified the risks, it is pertinent to analyse their order of importance so as to decide suitable control measures in reducing the risk to an acceptable level, Control measures are justified to the extent at which the cost of control is less than the benefits for reducing the risk.
Ben Carson, the author of Take The Risk’ said, “anyone who refuses to test his limits, anyone unwilling to move out of her comfort zone, is destined to live life inside the envelope.”
Questions to explore when organisations want to make strategic decisions are:
- What is the best thing that could happen if new strategy is deployed?
- What is the worst thing that could happen if new strategy is deployed?
- What is the best thing that could happen if Do-nothing strategy is employed?
- What is the worst thing that could happen if Do-nothing strategy is employed?
Risk exists whenever a future outcome or future event cannot be m predicted with certainty, and a range of different possible outcomes or events which seems to answer the above questions occur.
Four main types of decision-making in strategy situation are:
- Decision making under certainty.
- Decision-making under risks.
- Decision-making under uncertainty.
- Decision-making under competition and conflict.
Certainty: The decision maker is faced with a state of nature. However, there are several courses of action available from which to make a choice.
A good strategy will choose an alternative that will most like achieve the desired objective. For instance, a table water company will have to device alternative way of making sales in cold weather when demand for cold water hit bottom low.
Under risk: Complete information about the state of nature of risk is not available here. Strategy can only estimate the mathematical probabilities with which each of two or more states of nature may occur. Decision making can be drawn from trends or historical analysis. For example, if the table water company above is not sure or does not have information as to when exactly rain will start or winter wil set in, he can make decision based on pas sales experience.
Uncertainty: This third category of strategy situation is when the decision situation is uncertain. It occurs when you cannot assign objective mathematical probabilities to state of nature. The strategy embraced here are Subjective and sometimes based intuition.
Conflict: Strategy under competition or conflict is found where competing rivals in industry are contending for a share of the market. In such situations, consideration should be given to actions or reactions of other competitors to a new strategy. Strate. can use game theory to analyse the probable actions of others.
Risk can take two forms:
- Pure risks and
- Speculative risks.
- Pure Risk
Pure risk is the possibility of occurrence of adverse event that cannot be better than expected. For example, the possibility of a company workers going on strike in the event of company downsizing or salary cut is there. It is pure risk, because the expected outcome is ‘no strike’ but the possibility of a strike does exist. This form of risk can be controlled either by means of internal control or by insurance. That is why it can be called internal control risks or operational risks.
Speculative Risk
Speculative risk exists when the future outcome or event might be better or Worse than expected. A shareholder or an investor is exposed to a speculative risk, because the market price of the shares may go up or down. The investor will gain it prices go up and suffer loss if prices go down. Companies face speculative risk whenever they make business investment decisions.
Speculative risks cannot be controlled because risk must be taken in order to make profits. AS a general rule, higher risks should be justified by expectation of higher profits (although it could also turn out otherwise). This risk is called business risk, strategic risk or enterprise risk.
Risk Management
Risk management is the process of managing pure and speculative risks. It can be defined as the culture, structures and processes that are focused on achieving possible success yet at the same time control unwanted results.
From the definition, critical connection between risk and returns can be identified thus:
- The safest strategy is to take no risk at all (do-nothing). It is an unrealistic business strategy. All business activities involve risk.
- Enterprise decisions should be directed towards achieving its objectives. The main objective is to increase the bottom line (Profit) or shareholders’ value over the long tem.
- The strategy embraced by company should be consistent with the amount of business risk the company is willing to take, and the targets should be realistic for the chosen strategies.
- Strategies are implemented to achieve objectives, but managers should implement organisation strategy within acceptable levels of risk through managing their pure risks and limiting their business risks.
Types of Risks
There are no basic standards for risk classifications because the nature of risk varies for different types of business, Some risks common to many businesses are identtied below:
- Market risk
- Technological risk
- Liquidity risk
- Credit risk
- Legal risk
- Health, safety and environmental risk
- Reputation risk
- Business probity risk
- Derivative risk
- Market Risk
Market risk is the risk from changes in the market price of key commodities. The price sensitivity of customers in the market may spell fortune or doom for the company considering its product price elasticity. The company might be able to also pass on higher cost of raw materials to the customer by raising the price of its product. A Company share price may fall or improve as a result of its market risk decision.
Liquidity Risk
Business transaction is done mostly in money currency. When a company is faced With shortage of liquidity flow to settle liabilities when payment is due, then the company suffers liquidity risk. This can occur when the company has no money in the bank, is unable to borrow more money quickly, and has no assets it can sell quickly to become liquid worthy.
Credit Risk
All companies that gives credit to customers are exposed to credit risk. Such credit includes losses from bad debts or delays by customers in the settlement of their debts. The size of risk depends on the amounts of receivables owed the company. Credit risk is a major risk for commercial banks because lending is the major part of their business.
Technological Risk
Companies are faced with technological risks as a result of technological dynamism in the business environment. Companies may face the risk of adopting new technology too soon or delay in adoping new technology. Competitors may use new technology to take advantage and gain market share while the company may also incur more cost for adopting new technology too early. Finding a balance for technological risks is very important here.
Legal Risk
Legal risk is the risk of losses as a result of failure to comply with laws and regulations. In the same vein, companies are exposed to losses from the risk of legal actions and lawsuit against them. Example of legal risk is the case between MTN and NCC which was mentioned in the opening chapter of this book.
Health, Safety and Environmental Risk
Health and safety risks are the risks to the health and safety of the company stakeholders including employees, customers and the general public. Environmental risks are risks of losses the company may suffer from the stakeholders reactions result of damage to the environment
Reputation Risk
Damage to company reputation can arise in several wayS, though not quantifiable the risk of damage could have adverse reputation effect on the Company. Public relations consultants services may be needed to assist vith managing the risk
Business Probity Risk
Business probity risk is the risk of losses from failure of a company to act in an he way or uphold business integrity. Some companies engage in sharp practices portend short or long term risk for them. Business probity which should be seen business asset cannot be compromised by companies.
Derivative Risk
Derivative risk includes commodity derivatives and financial derivatives, Commodity derivates are contracts to buy and sell a quantity of certain commodities Such as food stuffs or industrial raw materials at a future date at a fixed price agreed in the contact. The force of contract is the payment of the difference between the fixed prices in the commodity derivatives are contacts on the price of certain financial instrument such as foreign exchange rates, interest prices and share prices. The contract is on the market rate which is settled by payment for the difference between the fixed price in the contract and the market rate at the settlement date.
Concepts in Risk Management
Some terms commonly used to express concepts of risk in risk management are briefly explained below
Exposure to Risk
A company is exposed to risk from potential damage it could suffer if there are unfavourable events in the future. The risk could be quantitative or qualitative in nature. The exposure to risk is not necessarily the amount the company will expect to lose from unfavourable events but it helps the company to measure its exposure to risk so it can estimate the possible losses realistically.
Residual Risk
Risk is a way of life. Despite companies suitable measures to manage and control their risks, controls cannot eliminate risks completely. The remaining exposure to risk after adequate control measures have been taken is called residual risk. Efforts must however be made to reduce residual risk to acceptable level.
The Dynamic Nature of Risk
Organisations business environment varies and so the internal and external factors affecting companies differ. This is saying risk faced by a company do not remain static but change overtime and in different situations.
Risk Appetite
Risk appetite is about the amount of capital a trader is willing to lose in order to generate a potential profit. Investment is about taking the risk of making a loss in order to create chance to make profit. A sole trader bears the risk of her business alone, partners bear the risk of business partnership while managers of a corporation manage the business risks on behalf of the shareholders. To wet an investment appetite is to engage higher risk with the hope of making substantial profit
A Risk-based Approach
The term risk based approach is an approach that is used to make decision based on risk assessment and exposures by embracing strategic guidelines on the level of risk that is acceptable.
The Impact of Risk on Stakeholders
In the process of identifying risks, management should be aware of the impact of the company risk, whether strategic risks or operational risks on stakeholders because the risk consideration which affect their interests may affect the attitude and the behaviour of the stakeholders towards the company. The impact of a company risk on their stakeholders varies depending on circumstances in their exposure.
Employees
The risks that employees are exposed to in their job include the risk of job loss, employment benefits, threat to heath and safety. Often, the risk appetite of the employees differs from that of the policy makers or the management.
Investors
Investors buy share from a company with the expectation of return on their investment (ROI). For example, an investor might buy a share from a company because it is stable financially and can pay a regular annual dividend. Managers should ensure that there is harmony between the risk appetite of the company and that of its shareholders
Creditors
The impact of risk to a creditor or a supplier is that, the company will not pay what they owe and the company will stop buying goods and services from them respectively. A high risk company is a high credit risk. Creditors like banks ensure they obtain collateral to secure loans to companies.
Communities and the General Public
Communities and general public are exposed to risks due to certain activities of some companies as they fail to control risk factors. Economic risk would be experienced by the community if a company closes down its production. Companies should provide palliative measures to allay the pains suffered by communities from risk of their operation.
Governments
Governments generate revenue in tax from companies operating in their country. Location of investment is a source of wealth to any county. It is a risk to governments when companies move its operations from their country.
Customers
End users of products face product risks from companies such as pharmaceutical companies and manufacturers of food products. Customers also face the risk of delay in supply of products from companies.
Business Partners
Risks in partnerships extend to frictions when it comes to decision making and varieties of partners interests. Risks can however be controlled d for partners – to some extent by clear contract agreement between the partners and by monitoring performance of the partners.