Key Risk Management Decisions - Essay Example

Key risk management decisions affiliation Key risk management decisions Risk management is a culture, structures and processes that are channeled towards effective management of adverse effects and opportunities that are potential. It is considered the process where assessment, identification and prioritization of risks are done then followed by economical and coordinated application of resources. This helps in minimizing and controlling the probability and the impacts of the harmful and unprecedented events or at the same time assist in maximizing the realization of the available opportunities (Finne 2000, pp.234–242). Risks come from various sources. They can come from financial markets uncertainty, threats originating from the failures of projects at any stage during the lifecycle, legal liabilities, risks in credit, and accidents among others. The strategies put forth to manage these threats, which are the negative uncertainties, include transferring the threats to a different party, trying to avoid the threat, attempting to minimize the negative consequences or threat probability. Some aspects revolving around the standards of risk management have been under intense criticism for having no improvement at all. In an ideal management of risk, the process of prioritization is usually followed. In this case, the risk that is seen to be having the greatest loss and high probability of taking place is handled at first as a priority. On the other hand, the other risks that seem to be having lower occurrence probability and low likelihood of loss are handled last in a descending order. In practice, the entire process of assessing the risks is complicated. Risk management faces enormous difficulties in allocating its resources. In addition to this, risk management also faces intangible risks and which are more often ignored by several organizations because they fail to identify it. Relationship risk results when there are ineffective collaborations among the employees. This risk is known to affect the employees productivity directly, and services delivered, profitability, brand value and decrease in the cost effectiveness (Wu et al. 2014, pp.1–7). Risk management decisions are usually derived directly from the characterization of the risks basing on the questions “does the characterization of risk indicate that adverse effects to receptors are likely?” The primary goal of risk management is selecting an environmentally and socially acceptable and a cost effective strategy that will help in mitigating the threats to, and help in providing protection for the welfare, financial status and the environment. In the modern economic environment, heightened governance responsibilities and a great extent of transparency are critical to the success of any company business. The casual hazard risks help to give a variable and large expenditure for several huge corporations. Given the substantial costs, there are large amounts of information that will be used by the business to quantify the risks. Because of this, it is imperative to note that any transfer decision of the casualty risk basing on the accuracy of representation of the range of the possible loss of outcomes. Due to the uncertain nature that exists in casualty risks, analyzes and create immediate value as huge costs, and major areas of uncertainty can be reduced or mitigated. While loss projections seem to be valuable from a macro business side of view, a stochastic modeling methodology and process can be able to provide the effect of understanding the risk variability of those projections. This dynamic analysis of risks can be performed using industry and client data loss while incorporating a thorough knowledge involving the companies’ projected and historical exposure. This will allow for most accurate and representation that is intuitive of the full range of loss of outcomes. With the variability measures loss and analysis of finance, clients can impute the value in the reduction of loss and the profile of finance. Risk managers are in a position to substantiate the decisions they make basing on the quantifiable measures. Given better collection of information and more strong techniques models and software’s, all these creates availability of quantifiable risk analysis. When making use of this form of analysis, insurance buyers who are sophisticated can easily take advantage of this market that is inefficient and in the end increase the overall value of their programs (Aloini et al. 2007, pp.547–567). The next step after the coverage of individual optimization and evaluation is expansion of layer analysis across all lines of coverage. After this, portfolio risk analysis can then use to measure against any form of enterprise risk management types of benchmarks including the risk bearing capacity. This type of analysis that is in depth allows clients to examine the range of the total portfolio hazard risk results against their tolerance level of risks and their willingness and capacity to bear any form of risk. Insurance can, therefore, be able to purchase at par with any other cost of capital decision measures that is made throughout the organization when these types of analyzes are in place. Direct and indirect costs Direct costs These are the costs that an organization or business incurs directly as a result of providing services and producing goods. This type of cost can be attributed directly to the organization’s services and goods. Unlike the indirect costs, this kind of cost is relatively straightforward to measure and identify. In normal organization operations, direct costs include resources such as materials, professional services and travel that are needed for direct operations of the organization, direct labor and acquisition of capital to the extent of contributing to the overall output of the organization or business (Malhotra & Temponi 2010, pp.28–37). This type of cost can be traced easily to a particular object such as raw materials. They are not variable costs. They are seen to be costs that were unintended and are incurred; as a result, on the action to be done. In most cases, direct costs are used when referring to the cost of the organization program. In risk management decisions, the challenges of direct costs measurements are linked with the reduction of such risk strategies that include the costs of hedging, insurance, control of activities and alliances. Insurance cost is the most traditional form of reduction of risks. It involves insuring assets that are tangible, and this is done through policies f insurance. In recent days, the policies of insurance have been extended beyond the traditional ways where assets were fixed to the risks that were associated with the events. Regardless of what the organization or business is insuring, there is always a cost that is linked to the insurance that is understood by most people. Secondly, when it comes to the cost of hedging, organizations have for long been protecting themselves from the risks associated with investments. They have been doing this through entering into hedges to try to limit the losses that are related to unfavorable movements in the variables of economy, which include rates of interests, rates of exchanges, and the prices of commodities. Thirdly, in cost of alliances, the formation of the alliance that is strategic is regarded as a risk response strategy. This is believed by most companies when they go ahead and seek to manage what they regard to be their risk exposures by making use of the organizational resources in order to achieve their objectives. In this case, it is hard for one of the organizations in partnership to increase its profile of risk on its terms and will before requiring from its new partner. Finally, in understanding the effectiveness of risk management it is important to take into consideration the control of activities. This is because the control m activities are linked with the investments that are done to reduce internal risks. Therefore, organizations should identify all costs of increment as well as the resulting net benefit that is linked with operating and implementing each control. All these can only be done when an organization is selecting the best risk reduction to be used in the control activity for implementation (Ferris & Lawless 1997, pp.1207–1236). In conclusion, the direct risks in the organization can simply be estimated in an easy way. For an organization or business project, the direct costs will simply include the total cost that will be used directly to ensure the project is completed. It is generated by summing up all the costs to be used directly in the project including the cost used in the purchase of raw materials and other resources. Direct Cost = All the total cost of resources Indirect costs These costs have to be allocated since they apply in more than one cost object. Most often, indirect costs originate in support of programs. These types of costs cannot be identified directly with the production or the sales of certain products. They are considered the necessary costs used in doing business. Most times, certain portions of indirect costs can be allocable properly to every contract that has some benefit from the cost (Trogdon et al. 2008, pp.489–500). Since several business contracts are affected by indirect costs, they need support from the either administrative contracting officers or auditor; this support is important to the analysis of the business Importance of indirect cost in cost analysis Despite indirect being critical consideration when it comes to analysis of the proposal cost, the share of the cost they stand to represent will vary from one firm to the other. For example, it is expected that the indirect costs represent a larger share of proposal cost for heavy manufacturing equipment than the one required for contract services. Services do not need to have the same level of investments in plant and equipment. Composition of indirect costs The term indirect costs encompass a variety of cost categories. The costs that are involved in indirect costs normally not all of them are incurred for the same reasons. In a single firm, the number of the indirect costs accounts ranges from one to several in terms of hundreds. In many businesses, indirect cost accounts fall into two broad categories: Overhead: These indirect costs are related to the support of operations that are specific in the business. They include manufacturing overhead, field service overhead, material overhead and site overhead. General and Administrative expenses: These indirect costs revolve around management, financial and other expenses in the organization. Most of the time they are related to the administration of the business unit and the general management units as a whole. They include selling and marketing expenses, salary and other executive staff costs and the salary and other costs of such staff services. Indirect costs allocation rates Normally, the indirect costs are not related directly to a single cost of the objective. As a matter of fact, indirect cost rates are used to know when the costs should be charged on certain products. In this case, the larger share of the direct effort of the contractor is used in the production of a given product. The use of indirect cost rates, therefore, ensures that the huge share of the cost incurred indirectly by the contractor supports the direct effort put. Indirect cost rate formula The rates of indirect costs are expressed in terms of dollars in an hour or the percentage of the total cost incurred. These rates are calculated for every accounting period by dividing the indirect cost pool for that period by the indirect cost allocation base that took place during the same period. Indirect Cost Rate = Indirect Cost Pool Indirect Cost Allocation Base Once an organization establishes the indirect cost rate, it can use it in determining the indirect costs that the contract should be allocated. This is gotten by multiplying the rate by actual amount or the amount estimated from the allocation base in the contract for a given period. Contracts that have an enormous share of the base allocation will be charged highly on its share that is related to the indirect cost pool (Liljas 1998, pp.1–7). On the other hand, contracts that have smaller shares on their bases will consequently experience smaller charges on their shares that are related to the indirect cost pool. Indirect cost pools are groupings of indirect cost done logically with similar relationship to the objectives put forth for the costs. If an indirect cost pool is developed properly, it should be able to allow the allocation of the indirect costs. Indirect Cost Rate = INDIRECT COST POOL Indirect Cost Allocation Base Conclusion For any project management, risk management decision is probably one of the most complicated aspects. The manager of the project must be able to identify as well as recognize the causes resulting to the risk. He should trace these causes throughout the project and be able to state their consequences. In addition, decision made on the risk management of projects are based on the costs to be incurred. The manager should be able to estimate the total costs the project is to incur whether direct cost or indirect cost. References Aloini, D., Dulmin, R. & Mininno, V., 2007. Risk management in ERP project introduction: Review of the literature. Information and Management, 44, pp.547–567. Ferris, S.P. & Lawless, R.M., 1997. Professional Fees and Other Direct Costs in Chapter 7 Business Liquidations. Washington University Law Quarterly, 75, pp.1207–1236. Finne, T., 2000. Information Systems Risk Management: Key Concepts and Business Processes. Computers & Security, 19, pp.234–242. Liljas, B., 1998. How to calculate indirect costs in economic evaluations. PharmacoEconomics, 13, pp.1–7. Malhotra, R. & Temponi, C., 2010. Critical decisions for ERP integration: Small business issues. International Journal of Information Management, 30, pp.28–37. Trogdon, J.G. et al., 2008. Indirect costs of obesity: a review of the current literature. Obesity reviews : an official journal of the International Association for the Study of Obesity, 9, pp.489–500. Wu, D.D., Chen, S.H. & Olson, D.L., 2014. Business intelligence in risk management: Some recent progresses. Information Sciences, 256, pp.1–7. Read More