risk analysis and risk mgt

and

Adrian Pegason&

Atty. Darwin TenajaDec. 2010

College of Governance, Business & EconomicsDepartment of Business Administration

FINANCIAL MANAGEMENTProf. R. Gabuya

overviewWhat is risk & risk mgt.

Why do we need risk analysis

Who uses risk management

How is risk management used?

The 7 basic process steps…

Component of risk

Overall categories of risk

5 primary means of risk mgt.

How?

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Prioritizing Which Risks to Address First

Risk mgt. is an individual decision

Porter’s 5 forces

Assessing the Balance of Power in a Business Situation

Usage

Risk mgt. team

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overview

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What is Risk and Risk Management

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What is Risk

Risk exists if there is something you don’t want to happen – having a chance to happen!!!

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What is Risk – Take 2

The probability that some event will cause an undesirable outcome on the financial health of your

business and/or other business/family goals

risk = probability of event x cost of event

- Single point forecasts are dangerous!

- Derive bounds for the range of possible outcomes

- Sensitivity testing of the assumptions

- Better perception of risks and their interaction

- Anticipation and contingency planning

- Overall reduction of risk exposure through hedging

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Why do we need risk analysis

Risk analysis helps you develop insights, knowledge and confidence for better decision making and risk management.

What is Risk Management?What is Risk Management?8

• Good management practice

• Process steps that enable improvement in decision making

• A logical and systematic approach

• Identifying opportunities

• Avoiding or minimising losses

Risk Management is a methodology that helps managers make best use of their available resources.

Who uses Risk Management?Who uses Risk Management?

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Risk Management practices are widely used in public and the private sectors, covering a wide range of activities or operations.

These include:

• Finance and Investment

• Insurance

• Health Care

• Public Institutions

• Governments

Effective Risk ManagementEffective Risk Management is a recognised and valued skill.

Educational institutions have formal study courses and award degrees in Risk

Management.The Risk Management process is well

established. (International RM process standards.)

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Who uses Risk Management?Who uses Risk Management?

Risk Management isnow an integral part of business planning.

How is Risk Management used?How is Risk Management used?

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The Risk Management process steps are a generic guide for any organisation, regardless of the type of business, activity or function.

There are 77 steps

in the RM process

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The basic process steps are:

Establish the context

Identify the risks

Analyse the risks

Evaluate the risks

Treat the risks

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‘Risk’ is dynamic and subject to constant change, so the process includes continuing:

Communication & consultation

Monitoring and review

and

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The Risk Management process:

The strategic and organisational context in which risk management will take place.

For example, the nature of your business, the risks inherent in your business and your priorities.

Communicate & consult


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Communicate & consultMonitor and review

Defining types of risk, for instance, ‘Strategic’ risks to the goals and objectives of the organisation.

• Identifying the stakeholders, (i.e.,who is involved or affected).

• Past events, future developments.

Identify the risks

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Analyse the risks

How likely is the risk event to happen? (Probability and frequency?)

What would be the impact, cost or consequences of that event occurring? (Economic, political, social?)

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Evaluate the risks

Rank the risks according to management priorities, by risk category and rated by likelihood and possible cost or consequence.

Determine inherent levels of risk.

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Treat the risks

Develop and implement a plan with specific counter-measures to address the identified risks.

Consider:• Priorities (Strategic and operational)• Resources (human, financial and technical)• Risk acceptance, (i.e., low risks)

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Document your risk management plan and describe the reasons behind selecting the risk and for the treatment chosen.

Record allocated responsibilities, monitoring or evaluation processes, and assumptions on residual risk.


Treat the risks

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Risk Management policies and decisions must be regularly reviewed.

Monitor and review

In identifying, prioritising and treating risks, organisations make assumptions and decisions based on situations that are subject to change, (e.g., the business environment, trading patterns, or government policies).

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Risk Management policies and decisions must be regularly reviewed.

Monitor and review

In identifying, prioritising and treating risks, organisations make assumptions and decisions based on situations that are subject to change, (e.g., the business environment, trading patterns, or government policies).

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Mon

itor

ing

and

revi

ew

Com

mun

icat

ion

& co

nsul

tati

on


Identify the risks

Analyse the risks

Evaluate the risks

Treat the risks

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Components of Risk

Probability

of 5%

Probability

of 15%

Probability

of 60%

Probability

of 15%

Probability

of 5%

EVENT

Cause/Source

Hail

Odor lawsuit e.g. fpic.

Disabling farm accident

Surplus Production

Increasing interest rates

Potential Outcome #1

PotentialOutcome #2

PotentialOutcome#3

PotentialOutcome#4

PotentialOutcome#5

[minor nuisance] [catastrophic]

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Components of Risk – Undesirable Outcome

Put simply, the Undesirable Outcome is what hurts!

- lower than expected production- catastrophically lower production- inability to meet cash flow- loss of income- catastrophic loss of income- loss of life- loss of buildings & other resources- loss of health- inability to get a permit or loan

Denied

X

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Components of Risk – Event (Cause/Source of Risk)

The Event is what caused the hurt:

- weather event- injury/death of an employee- neighbors action against you- surplus production of milk- widespread poor grain production- low quality inputs- divorce or disagreement- downward slide in general economy- and countless more!!!

Family Goals& Objectives

Overall Categories of Risk

Legal Risk Price Risk

Environmental Risk

5 D’s Risk- Death- Disability- Disagreement- Divorce- Disaster

Production Risk

Human Resources

Risk

Financial Risk

Relationship/Public

Relations Risk

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Risk Increases the More You Don’t Know

All The Potential Outcomes

The Probability of Occurrence

Cost of a Undesirable Outcome

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All The Potential Outcomes

The Probability of Each Outcome Occurring

Cost of Undesirable Outcomes

Said Another Way:The more you do know and understand about

the better long term risk manager you will be.

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What is Risk Management?

Assuring An Outcome

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Five Primary Means of Risk Management

Reduce1. Reduce the probability that the event will occur2. Reduce the impact if the event does occur

Transfer 1. Transfer the cost of an undesirable outcome to someone else

Avoid1. Completely avoid potential events thus providing a zero

probability that they will occur

Do Nothing 1. Let the risk happen and be ready to bear the consequences.

e.g. pcso

Level of Production

Employee Performance

Interest Rates

Personal Injury/Death (you, employee, spouse)

Divorce

Disagreement

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32Production Risk

Risk: Poor weather event causing the undesirable outcome of lower than expected yields.

Risk Management???

160 19595

Corn Yields

Transfer the cost of the

risk via crop insurance

33Production Risk:Risk: of a poor weather event causing the

undesirable outcome of lower than expected yieldsRisk Management???

160 19595Corn Yields

Reduce the cost of the risk via spatial location, multiple variety selection, and other cropping practices.

34Financial RiskRisk: higher interest rates causing the undesirable outcome of lower than expected income/cash flow

Risk Management???

Do Nothing

Cash Flow


Risk Management???

Cash FlowTransfer the risk via fixed

rate loans Do Nothing


Risk Management???

Transfer the risk via fixed

rate loans

Reduce the cost of the negative

impact via lower debt financing

Do Nothing

Cash Flow

37Human ResourcesRisk: Cost of hired labor not showing up or making a

mistake causing lower production, injury, or deathRisk Management???

Reduce the Risk via:-Regular employee meetings-Training programs-Well written position descriptions-Incentive plans

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Transfer the risk via

disability and other

insurance

Human ResourcesRisk: Cost of hired labor not showing up or making a


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Avoid the risk by not hiring

any employees

Human ResourcesRisk: Cost of hired labor not showing up or making a


40Environmental RiskRisk: manure spill causing the undesirable outcome

of fines, lawsuits, and loss of incomeRisk Management???

Reduce the risk via:-Education-Facilities-Monitoring checks and systems-Field and manure trt. practices

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Transfer the risk via liability insurance

Environmental RiskRisk: manure spill causing the undesirable outcome

of fines, lawsuits, and loss of incomeRisk Management???

42Disability Risk

Risk: poor health causing loss of incomeRisk Management???

Incapacitated Avg. Health

Reduce incidence or impact of risk via:-Annual health exam - Quit smoking-Exercise -Disability Insurance-Co-Manager

43So, I now know What Risk Management is, but

How do I do it???

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How???• Step 1: Be aware, identify the risks you face.• Step 2: Evaluate:

– the likelihood that the risk will occur, and – how bad the hurt will be if it does occur

• Step 3: Decide on how you will address the risk – reduce, transfer, avoid, nothing, or some combination

• Step 4: Implement– What is the most frustrating words used in management??

Answer: “If I had only ……”

• Step 5: Control– Monitor to assure that what you said you would do, you did, and

that you are getting what you want out of your your risk management strategies.

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Prioritizing Which Risks to Address First

Probability of Happening

Potential Impact

Act if cost effective

No action required

Immediate action

Action required

Small Catastrophic

High

Low

Source: Dr. Geoff Benson, North Carolina State University

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Risk Management Is An Individual Decision

No one "right" decision

The "right" decision depends on the characteristics of the

operation and individual decision-maker

Risk

Revenue

1

2

3

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Risk vs. Profitability

Risk

Revenue

1

2

3

Porter’s 5 forces

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Is a framework for the industry analysis and business strategy development formed by Micheal E. Porter of HBS in 1979.Attractiveness in this context refers to the overall industry profitability. An "unattractive" industry is one in which the combination of these five forces acts to drive down overall profitability. A very unattractive industry would be one approaching "pure competition", in which available profits for all firms are driven down to zero.

Assessing the Balance of Power in a Business Situation

The Porter's 5 Forces tool is a simple but powerful tool for understanding where power lies in a business situation. This is useful, because it helps you understand both the strength of your current competitive position, and the strength of a position you're looking to move into.With a clear understanding of where power lies, you can take fair advantage of a situation of strenght , improve a situation of weakness, and avoid taking wrong steps. This makes it an important part of your planning toolkit.Conventionally, the tool is used to identify whether new products, services or businesses have the potential to be profitable. However it can be very illuminating when used to understand the balance of power in other situations too.

Usage52

Strategy consultants occasionally use Porter's five forces framework when making a qualitative evaluation of a firm's strategic position. However, for most consultants, the framework is only a starting point or "checklist" they might use " Value Chain " afterward. Like all general frameworks, an analysis that uses it to the exclusion of specifics about a particular situation is considered naїve.According to Porter, the five forces model should be used at the line-of-business industry level; it is not designed to be used at the industry group or industry sector level. An industry is defined at a lower, more basic level: a market in which similar or closely related products and/or services are sold to buyers.

A firm that competes in a single industry should develop, at a minimum, one five forces analysis for its industry. Porter makes clear that for diversified companies, the first fundamental issue in corporate strategy is the selection of industries (line of business) in which the company should compete; and each line of business should develop its own, industry-specific, five forces analysis. The average Global 1,000 company competes in approximately 52 industries (lines of usiness).

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Your RiskManagement

Team

Extension AgentLenderBroker

Dairy ConsultantMilk Buyer

Input Supply ManagersOther ProducersInsurance Agent

Nutrition ConsultantCrop Consultant Attorneys

Technical College Instructors

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Success leads to both personal and legal complications

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: )