“Risk is everybody’s businesses”
All companies are exposed and respond in various time-honored ways to traditional business risks such as deviation to earning as changes in the business environment, in the nature of competition, in production technologies, and in factors affecting suppliers. It’s a classic business decision-making but through engaging risk management will allow management to have better control over firm’s natural economic performance.
How firms put risk management into practice? In answering that question, at least there are 5 steps need to be considered.
Determining the objective
A corporation should not engage in risk management without deciding clearly on its objectives in term of risk and return. It is senior management’s prerogative and used as a guiding policy for management actions.
For each objective that made by senior management, it’s important to have time horizon on each objectives and criteria for examining whether the objective is achieved.
Mapping the risks
It’s essential to map the relevant risks and to estimate their current and future magnitudes. When mapping a firm’s risks, it’s important differentiate between risks that can be insured against and risks that are uninsurable. This classification is important for opting instruments for managing risks.
Opting instruments for managing risks
Firms should collect any competing offers to manage the risk identified as transferable or insurable during risk mapping process, therefore management could evaluate each decision based on the likely costs and benefit. Some of the instruments can be devised internally through enhancing procedures, physical supervisory, or revise their business process.
Constructing and implementing a strategy
Senior managements must have access to all relevant corporate information, market data, information-based statistic, and business model before attempting to devise a strategy. Things need to be taken as consideration is the approach (dynamic or static approach), planning horizon, accounting issues and potential tax effect.
- In a static strategy, the firm develop a strategy that match to risk exposure as exactly as possible and maintain the strategy for as long as the risky position exist. In the other side, to develop a dynamic approach, the firm must have sophisticated and reliable models, also the staff and skills to put this tools to use.
- Planning horizon should be made consistent with performance evaluations.
- Accounting and tax considerations can be very important since they affect the cash flows of the firm.
The corporate risk management system must be evaluated periodically to assess the extent to which the overall goals were achieved, not whether specific transactions made a profit or loss.
DC | 2012
reference: Michel Crouhy, Dan Galai, Robert Mark (2005) The essentials of risk management