Financial Strategy of a Firm - Coursework Example

? Financial Strategy Financial Strategy Q1. A firm’s risk consciousness governs the underlyingstrategies that are employed by the enterprise. To what extent do you agree with this statement? Ans: The immediate response to this question is that I fully agree with the statement. However, before the topic is discussed at length, let us find what risk is and how it becomes a part of consciousness. Once this is established, we will go in depth about the underlying strategies. Today’s world is full of risks and their management has become a complex issue. Since, the two world wars and lot of scientific inventions, risk has been defined in many ways. When we go to the bus stand for the bus, various degree of risk is involved having different severity of accidents. Sometime risks may be voluntary or some risks may be trivial while other may be fatal. It may be argued that since the birth of civilization only risks have been responsible for any major advancement. In ancient times, risk taking cavemen lived with abundance of food and risk averse starved to death. In terms of financial theories and practice the risk management is equating risks with hedging. Organizations prosper not by avoiding risks but by managing risks to their own advantage. Ancient trade across the continents flourished because of risk taking and management. The key reason for Europe’s prosperity is risk management. In 1921, Frank Knight summarized the difference between risk and uncertainty with an example. “Two individuals drawing from an urn of red and black balls; the first individual is ignorant of the numbers of each color whereas the second individual is aware that there are three red balls for each black ball. The second individual estimates (correctly) the probability of drawing a red ball to be 75% but the first operates under the misperception” (Knight 1921). Numerically, financial risk is measured as Beta in capital asset pricing model Compound charge of interest penalty during the period is given as: While, management risk is measured by Holton (2004) explains two ingredients of risks: uncertainty and utility of the outcome. He explains that a man jumping out of a plane without parachute is at no risk at all, because of the certainty of death. Risks provide opportunities for a good outcome out of a bad situation. If the reward outmatches the hazard of disaster, people are ready to take risks. If a firm is conscious of the risks it is undertaking, it is going to formulate strategies based on the decision. The Institute of International Finance (December 2009) has defined risk culture as “as the norms and traditions of behavior of individuals and of groups within an organization that determine the way in which they identify, understand, discuss, and act on the risks the organization confronts and the risks it takes” (2009). It is essential that the risks are challenged by the core group of decision makers with an objective to develop a spirit of nurturing buoyancy and inculcating an environment for continuous improvement, in line with the strategic aims of the organization. Business risk is related to political and social environment of a country. During the war on terror and US attack on Iraq, the air travel became very risky and the insurance cost and cost of flying were many times higher than the previous prevailing rates. Similarly, in today’s world condition in Afghanistan is a threat for any kind of manufacturing business. Thus, no company would like to establish a factory in Afghanistan. Therefore, we observe that a lot of trading is going on these days in this region of the world. The uncertainty of terrorism has created a status of risk in almost the entire world for the last couple of decades, more appropriately since US invasion of Iraq. As a result of risk investment has moved out from this region. Despite the fact the countries in these regions are offering business incentives to the investors but in view of the high risk for capital and life, investors are not interested to invest in these countries. Another risk has arisen in recent years in the third world countries. Local people capture the assets of multinationals and even the court ruling cannot give the property back to the original owners. Sometimes, even the courts do not support the multinationals. Another problem in the underdeveloped countries is the transfer of technology and patent rights. Despite valid patent rights, once a technology is transferred to an underdeveloped or developing country, the local entrepreneurs do manufacture and market the patented products. The court proceedings are made too long and delayed, as a result by the time court rulings are given in favour of the multinational, the patent is already expired. This was most prevalent in China and India. China has committed to abide by the patent law just recently about a couple of years back or so. India is still very reluctant in following the patent laws in spirit and action. This indicates that ethical issues also play a major part in risk management. Risk is also a factor that have compelled or motivated organizations for taking safety measures (Pidgeon 2011) in their businesses in general and manufacturing facilities in particular. Safety became a major concern after the Chernobyl disaster. Even in the recent oil spill in the Gulf of Mexico raised many eyebrows for safety measures of British Petroleum. Safety measures have given a new concept in risk handling and management. In multinationals safety culture is globalized on a local basis with international parameters. Companies have developed standard operating procedures (SOP) for maintaining safety measures in the in their organizations. The culture of safety takes into consideration the role of norms, beliefs, and practice of handling hazards and risks with a safety driven attitude and reflexivity on safety practice. Risk consciousness appears to be more organizational than client based. For example it has been seen that loan write offs have to do more with the organizational operations rather than the borrowers e. g. improper documentation. In most of the cases the write offs originated from such avoidable mistakes. It is a challenge to the senior management to acknowledge and solve such problems. Usually the problems are undertaken on a burning platform, when it is already late. But it can be solved effectively with key performance metric in the evaluation of business managers. Operational risk manager should monitor, manage and measure risks. In the organizations there should be a chief risk officer like the chief credit officer. The compensation should also be linked with effective risk management. Each risk manager should be accountable for his performance. For example an employee complaining of certain illness may be given a lighter job rather than paid leave. This will help to maintain the cost structure. Contract negotiation and financial implications need to be assessed in the same perspective. Carrot and stick culture is very well established in this reference. ABN AMRO Bank was facing problem since the beginning of the new millennium. The bank was acquired by RBS (Royal Bank of Scotland). The largest takeover in the history of financial management, the acquisition turned out to be hostile and $100 billion was at stake. It was argued that this was a trick to prevent any other party to get involved in the takeover. This was followed by a merger with Barclays. To minimize the risk, it was decided that merger with Barclays would keep the ABN intact favoring long-term interests of the bank. Risk management is such an important job that must be handled by every employee of the organization. While the hard side of risk management like insurance policies and reporting system are taken care of the soft side like value creation, delivery and maintenance are ignored to a great extent. People need to be motivated for a better loss control. In recent years decentralization is viewed as a tool for effective risk management. Recently to reduce the cost, certain services e.g. Customer Relationship Management (CRM) are being outsourced to developing countries like India and China. These are considered risk free or low risk assignments. In addition to customer relationship management, they are also being used for sales calls. It has been seen that the far distance sales calls produce better sales results at a much economical cost. Return on net asset (RONA) is a major consideration while deciding for any investment. Profitable venturing and better utilization of underutilized assets are part of the decision making process. All the above risk concerns help the organizations in capital raising, capital management and profit management appropriately within the defined time frame. They help the companies in capital inflow, capital outflow and capital profit as their ultimate objectives. Therefore, it is clear that the firms’ understanding and consciousness of risk involved shape up the strategies employed by companies. Effective risk management optimize efficiency, increase effectiveness and maximize visibility. The risk indicator monitoring helps the owners to start timely modifications. It aligns the key risk indicators in the relevant business functions for risk mitigation. The cross system integration helps to have a wider view of the issue and provide transparency into risk exposure and execution. List of References Holton, G. A. 2004. Defining risk, Financial Analysts Journal, Vol 60, No. 6, pp 19–25. Institute of International Finance. December, 2009. Reform in the financial services industry: strengthening practices for a more stable system, The Report of the IIF Steering Committee on Implementation (SCI). Institute of International Finance. Knight, F. H. 1921. Risk, uncertainty and profit, New York: Hart, Schaffner and Marx. Pidgeon, N. F. 2011. Safety culture and risk management in organizations, Journal of Cross Cultural Psychology 42 (1), January 2011, London: Birkbeck College, University of London. Read More