Corporate Risk Management - Literature review Example

Corporate Risk Management Contents Corporate Risk Management Contents 2 The key risk management decisions 3 Introduction 3 The direct costs and benefits of these decisions and how might they be estimated. 6 Evaluating benefits against costs 7 The indirect costs and benefits and how might they be estimated 8 Conclusion 11 The key risk management decisions Introduction Risk management is the assessment, prioritization and identification of risk. It is followed by the economic application & coordination of resources. It is done for monitoring, minimizing and controlling possibility and the impacts of unfortunate events. Now a day’s risk management is a fast moving corporate agenda. So mismanagement of risk can create a huge loss in an organization. Risk can arise from many sources in a business. The sources are like project failure threats, uncertainty of financial market, credit risk, and risk related to the production process, legal liabilities, natural disasters, accidents, etc. The institute like the National Institute of Standards and Technology, the Project Management Institute etc have developed many risk management measures for managing all financial risk of the organization. The definition, methods and goals vary with the methods used in the project management, financial portfolio, industrial process, etc. (Loosemore, Raftery, Reilly and Higgo, 2012, pp. 37-40). Corporate risk management is a multi stage process. It depends on the requirement and need of the organization. In the first stage it finds out the exactly what and which type of risk the business is facing. Then it analyze its impact on the business with the help of the incident occurring. (Scheffran, 2007). The key decisions for managing the risk in a corporate organization are as follows: Avoidance It is the easiest decision taken by the business organization. Here the business stops all those activities which can put the business in risk and loss. But it should be remembered that businesses have to take risk for achieving its goal. So this decision is not always a realistic one (Scheffran, 2007). Reduction It means minimizing and reducing the business process or dealings that are causing risk. The risk return strategies used in this process are required to be judged with their potential return on investment. When the risk reduction cost describe the potential cost of incident or risk occurring then the business can decide the value of this decision (Scheffran, 2007). Transfer One of the popular risk managing decisions is transferring the risk to other party or organization. For example purchasing business insurance by the firms and transferring the recovery of many risks to the insurance company. It is one of the realistic options in managing risk. It accepts the fatal incidents which can happen in the business and ensuring the business to cope up with the results of such incidents (Loosemore, Raftery, Reilly and Higgo, 2012, pp 69-72). Acceptance It is the decision of accepting the risk and its impact. This decision is taken by those businesses that things that the cost of risk reduction and transfer is not required in their business. This decision can be dangerous as the business carries the risk of potential losses which are underestimated. Therefore it can result in vulnerable as the incident occurs (Loosemore, Raftery, Reilly and Higgo, 2012, pp 84-87). Control Business often takes decisions for controlling the factors which involves in initiating the risk. By this method the firm examines the potential losses and initiate actions for eliminating or reducing those factors. For taking this decision the firm evaluates the technical and non technical potential risk factor in the business operations. Financial policies and other policies related with the risk factors (Garlick, 2007). Risk retention Some businesses also follow a process of self insurance where the business keeps a reserve fund for managing unexpected financial losses and claims. In this method of managing risk the company doesn’t have to pay insurance charges to other company for insuring their own company’s risk. The business gets the full benefit of the money it has kept reserved. Unlike the insurance company no charges are deducted from the money (Garlick, 2007). Strategies The business decisions involved in the formation and changing of financial strategies help in the risk management of a firm. Many strategies and policies are there in the company for managing the financial matters. Some of those strategies may not be good for handling the risk involved in the business. So analyzing those strategies, changing and rebuilding it is a key decision for managing risk (Garlick, 2007). Captivity Based Planning Making plan in the business and giving priority to those aspects of the business which might give greater returns on investment with low risk. This decision will help to determine which capabilities of the business are most useful for the organization. It will also indentify the potential capability gap (Garlick, 2007). Adaptability The decisions taken by the organization for designing risk management actions, process and strategies is known as adaptability. For these decisions the process to manage risk and covering up the risk become very responsive and dynamic (Yoe, 2011). All these decisions are taken by corporate business organizations for managing the risk involved in different stages of their business. For Example – In Coca Cola company environmental and societal risk are considered as strategic business risk. These are annually assembled in the part of the company’s risk management process. Coca Cola will introduce an enterprise Risk Council which will be responsible for ensuring that all the risk are considered and understood in the company’s decisions (Yoe, 2011). The direct costs and benefits of these decisions and how might they be estimated. Business organization takes many decisions for managing the risk involved associated in different stages of the business. If those decisions are not sufficient enough then the business faces large shocks which can prove devastating for the business. The measures taken for handling this risk are also costly. The cost benefit analysis of those measures is one of the ways to evaluate those (McLucas, 2003). Evaluating benefits against costs In any cost effective calculation the benefits of an intervention and the likely costs are estimated. The business makes attempts to calculate the cost of an inventory by the process of estimating direct costs associated with the action in a specific area. The direct benefits the business gets after evaluating this are like estimation of the material damage of the organization, loss of the employees, different monetary loss etc. All these estimations are based on pessimistic or optimistic assumptions. The detailed study of this costs helps to give an estimation of the annual average cost a business should incur for managing its risks. It can also calculate the frequency of the risk occurrence based on the cost associated with the risk management and the history of the business. These direct approaches and interventions appear very cost effective to the business as it expands the time horizon and thus the occurrence of the risk becomes very likely. It helps to match the time horizon of the intervention with the cost benefit analysis of that time horizon. The benefits of the risk management are experienced in future but costs for experiencing those benefits are incurred in present time (McLucas, 2003). There are many other factors which could influence the risks of a particular business like the credit constrains, intensity of the probable factors initiating the risks, the distributional impact of the distribution of a project or the political factors. The businesses have to make very careful decision regarding these directs factors to calculate its potential cost & benefits. Risk transfer is a major direct cost involved in maximum business. The internal way of risk transferring involves the process like keeping reserve funds in the business for future incidents. Selective hedging of funds is also done by the business as the shareholders risk management, transaction cost may not be the perfect substitute for risk management in corporate industry and in many situations the company could be forces to bear operational risk. This type of risk can be handled if the company takes competitive advantage on its rivals. This method provides the company a good access in the capital market. The management can utilize this process in determining shareholder value. The firm’s net cash flow can estimate with its financial expose. For example a firm enjoying its advantageous position in the commodity market, credit market or foreign exchange market and involved in some particular hedging strategies for avoiding the financial losses associated with the risk. The firm is attempting to capture the benefits of the direct cost it has incurred by doing hedging. Another direct cost example of absolute risk reduction is a clinical trial of drug is done for preventing migraine. Out of 100 people 2 was taking the drug. They experienced a migraine of 2% in comparison with another set of 4 people out of 100 who were taking placebo (4%). 2% is the absolute risk reduction (4% - 2% = 2%) this means there were 2% migraine people consuming this drug. The difference between absolute risk reduction and relative risk reduction is important to understand by the business. The relative risk means the proportional difference and the absolute risk is the difference rates (McLucas, 2003). The indirect costs and benefits and how might they be estimated Indirect costs involve those costs which are associated in accidents of employee which are not covered up in the compensation of the workers. It is difficult to calculate indirect cost rather than direct cost because that information is not so recorded. But this is still important to estimate indirect cost as they are many times more than the direct cost. The indirect cost of the company is expressed in ratio to the direct workers, compensation cost like 4:1. For example one dollar of worker with the compensation cost there remains an associated indirect cost of 4 dollar. No method & formula is there for estimating indirect cost. Thus a business can determine and develop its own accidental cost ratio which will accurately reflects its own operations and own experiences (McLucas, 2003). These costs are estimated by maintaining some guidelines. These are as follows: Cost of the injured employee After an accident injured employee can get assistance from some of the other employee or co workers of the business for obtaining assistance & medical treatment provided by the claims of the worker’ compensation. The cost is calculated on the time given by the employee for offering assistance to the injured employee. This time is multiplied by the individual rate of payment of the employee (Gupta, 2013). Lost production This might happen when the equipments of the production process is out of order like sitting idle because of an accident, machineries and tools being repaired. These costs can be calculated by finding out the employee who can’t work for accident, machinery issues. The amount of time is calculated when they faces production slowdown and after that multiplying the rate of payment of those employee (Gupta 2013). Injured employee non compensation time After an injury employee might lose his time from the scheduled working hours but may not get benefits of workers compensation. The compensation time includes the injury day, and seven days after the accident. The non compensated time of the worker after returning to the work includes session for sick leaves and other medical care. Leave payment of this type are included in indirect tax related to non compensation. Total non compensated time is calculated and multiplied by the rate of payment of the employee (Gupta, 2013). Activities of the supervisor The supervisor of the injured employee is needed to do some activities associated with the accident. As a result the he can’t perform his other activities related to his duty. The amount of time the supervisor spent is calculated and multiplied with the supervisor’s salary for deriving the indirect cost (Gupta, 2013). Overtime work- Often employees have to work for additional hours to comply the work left by the injured employees or employees who are on leave for some reason. Such additional hours of work accounts as additional and compensation are being paid for such work. The amount of money withheld to serve the additional labor hours must be accumulated or estimated in the indirect cost figures (Guptal, 2013). Loss of output from replaced employees: the replaced employees will require some time to adapt to the learning environment and get trained to job requirements. This leads to reduction of output as the temporary or the newly recruited employees needs time to perform at the optimal level. This fall in output must be accounted in the indirect cost measures. A specific parameter or a measure scale can also be established to calculate the loss. It may be the case that the newly recruited employee will account to only 50% of the performance level offered by the permanent workers. (McLucas, 2003). Costs on Return to work Program: the administrative costs of return to work are calculated under the indirect cost figures. The costs which are included within the cost of return to work are salaries of the employees, equipment cost, office space and some other related cost (Garlick, 2007). Conclusion Risk Management is done for maximizing the scope of realizing the opportunities of business. In the recent times many businesses have witnessed the increasing number of corporate debacles which have shown huge financial loss in the business with the decrease of share values and damage of reputation. The corporate risk management helps the business to determine its techniques and decisions for managing risk. There are many direct and indirect cost and benefit associated with the process of risk management. A business can get different types of shocks. The shocks can be of different types like company facing economic crisis, natural disaster, loss of employee etc. The risks are uncertain so the business faces a problem to determine the measures taken for handling the risk is sufficient or not. Costs are then compared and estimated for preparing measures in managing the risk of the business. Whether a decision is considered as cost effective relies on many factors like the probability of the risk occurrence, intensity and degree of the risk. Sometimes benefit cost analysis can be enriched by discussion of directs factors which are very difficult to quantify. The company can transfer its risk internally and externally to cape up its financial losses. Damage to machineries and raw materials: accidents may cause to loss of raw materials and damage the machineries. The cost of repairing the damaged machines or installing a new machine should be included on the indirect cost estimates. References Garlick, A. 2007. Estimating Risk: A Management Approach. Hampshire: Gower Publishing. Gupta, A. 2013. Risk Management and Simulation. New York: CRC Press. Loosemore, M. Raftery, J. Reilly, C. Higgon, D. 2012. Risk Management in Projects. London: Routledge. McLucas, A. 2003. Decision Making: Risk Management, Systems Thinking and Situation Awareness. Australia: Argos Press. Scheffran, J. 2007. Advanced Methods for Decision Making and Risk Management in Sustainability Science. New York: Nova Publishers. Yoe, C. 2011. Principles of Risk Analysis: Decision Making Under Uncertainty. New York: CRC Press. Read More