Question

Risk management is an important part of managing many farms and ranches. I want you to begin to grasp what risk management means. I also want you to be able to talk about risks that are faced and learn how to manage them. You will use the information gathered this week in your assignment next week. For next week read p 24-32, 219-221 (sixth edition) 118-140(seventh edition) in the text book. Talk to your parents or someone else that runs a farm or ranch and ask them the following questions:

1. Which of the risks that your operation faces do you think are the most critical?

2. Has this changed over time? If so, how?

3. What do you do to manage your risks?

4. What do you see as the biggest risks for the future?

Answer 1

Risk Management

In the world of finance, risk management refers to the practice of identifying potential risks in advance, analyzing them and taking precautionary steps to reduce/curb the risk.

When an entity makes an investment decision, it exposes itself to a number of financial risks. The quantum of such risks depends on the type of financial instrument. These financial risks might be in the form of high inflation, volatility in capital markets, recession, bankruptcy, etc.

So, in order to minimize and control the exposure of investment to such risks, fund managers and investors practice risk management. Not giving due importance to risk management while making investment decisions might wreak havoc on investment in times of financial turmoil in an economy. Different levels of risk come attached with different categories of asset classes.
For example, a fixed deposit is considered a less risky investment. On the other hand, investment in equity is considered a risky venture. While practicing risk management, equity investors and fund managers tend to diversify their portfolio so as to minimize the exposure to risk.

Types of risk business faces

Business risk is a broad category. It applies to any event or circumstance that has the potential to prevent you from achieving your business goals or objectives. Business risk can be internal (such as your strategy) or external (such as the global economy).

You should not manage or treat in the same way all types of risk. You should understand what type of risk you are facing, before you consider how to deal with it.

Types of business risks

The main four types of risk are:

• strategic risk - eg a competitor coming on to the market
• compliance and regulatory risk - eg introduction of new rules or legislation
• financial risk - eg interest rate rise on your business loan or a non-paying customer
• operational risk - eg the breakdown or theft of key equipment

These categories of risks are not rigid and some parts of your business may fall into more than one category. The risks attached to data protection, for example, could be considered when reviewing both your operations and your business' compliance.

Other sources of business risk

Other factors can present certain threats to your business, including:

• environmental risks, such as natural disasters
• political and economic instability in any foreign markets you export goods to
• health and safety risks - see health and safety risk assessment
• commercial risks, including the failure of key suppliers or customers
• workforce risks, eg maintaining sufficient staff numbers and cover, employee safety and up-to-date skills

How to manage risk in business.

To create a plan that's tailored for your business, start with these steps:

1. Identify risks

What are your risks and how likely are they to occur? Some will cause major disruption while others will be a minor irritation. You must make an educated assessment of both the likelihood and potential severity of each risk to prioritise your planning efforts.

2. Minimise or eliminate risks

Once risks have been identified you need to either eliminate or minimise those risks. You should provide specific strategies for minimising risk for each of the six subgroups.

3. Identify who has to do what should a disaster occur

One of the simplest and most powerful tools for a speedy recovery from a disaster is a clear picture of, and clear directions about, who has to do what should your disaster plan have to be enacted.

Sample of response checklist

4. Determine and plan your recovery contingencies

Recovery contingencies should be determined by the type, style and size of your business and by the extent of the damage.

Use our Emergency Contingency Planner to make sure you cover all bases.

5. Communicate the plan to all the people it refers to

This stage of planning is all about ensuring that all people within your business sphere (staff, suppliers, contractors, service providers) are made aware of the strategies you have put in place to either mitigate or recover from a disaster situation. Make decisions about whether the physical communication will be done by phone, email, text or other means. Once these decisions are made, procedural statements can be created and relevant people can be informed. The next part is to train staff and ensure everyone practices what has been done so if a disaster occurs the process can take over and guide the staff.

During day to day operations, any number of risks can pop up in a business so it is important to know how to identify any potential risks before they escalate. This will help you develop realistic and effective strategies for dealing with risks if they occur.

6. Prepare a risk management plan

A risk management plan can help minimise the impact of cash flow issues, damage to brand and other risks. It will also help create a culture of sensible risk awareness and management in your business. Our Crisis planning for business template below includes a risk management plan.

Ans.(i) The Main Types of Business Risk

1. Strategic Risk

Everyone knows that a successful business needs a comprehensive, well-thought-out business plan. But it’s also a fact of life that things change, and your best-laid plans can sometimes come to look very outdated, very quickly.

This is strategic risk. It’s the risk that your company’s strategy becomes less effective and your company struggles to reach its goals as a result. It could be due to technological changes, a powerful new competitor entering the market, shifts in customer demand, spikes in the costs of raw materials, or any number of other large-scale changes.

2. Compliance Risk

Are you complying with all the necessary laws and regulations that apply to your business?

Of course you are (I hope!). But laws change all the time, and there’s always a risk that you’ll face additional regulations in the future. And as your own business expands, you might find yourself needing to comply with new rules that didn’t apply to you before.

3. Operational Risk

So far, we’ve been looking at risks stemming from external events. But your own company is also a source of risk.

Operational risk refers to an unexpected failure in your company’s day-to-day operations. It could be a technical failure, like a server outage, or it could be caused by your people or processes.

In some cases, operational risk has more than one cause. For example, consider the risk that one of your employees writes the wrong amount on a check, paying out $100,000 instead of $10,000 from your account.

That’s a “people” failure, but also a “process” failure. It could have been prevented by having a more secure payment process, for example having a second member of staff authorize every major payment, or using an electronic system that would flag unusual amounts for review.

4. Financial Risk

Most categories of risk have a financial impact, in terms of extra costs or lost revenue. But the category of financial risk refers specifically to the money flowing in and out of your business, and the possibility of a sudden financial loss.

For example, let’s say that a large proportion of your revenue comes from a single large client, and you extend 60 days credit to that client (for more on extending credit and dealing with cash flow, see our earlier cash flow tutorial).

In that case, you have a significant financial risk. If that customer is unable to pay, or delays payment for whatever reason, then your business is in big trouble.

Having a lot of debt also increases your financial risk, particularly if a lot of it is short-term debt that’s due in the near future. And what if interest rates suddenly go up, and instead of paying 8% on the loan, you’re now paying 15%? That’s a big extra cost for your business, and so it’s counted as a financial risk.

Ans(ii) Risk management has changed according to the situations in business.

1. Risks are tied to outcomes

Risk management up until now has been focused on loss prevention. Attention is given to understand the probabilities of events that may negatively impact our programs, systems or processes. This has been helpful but often results in risk registers being filled with risks, many of which, that do not really matter. Connecting risks to objectives allows risk managers to know which risks to address and which ones to ignore.

2. The focus of risk is on the effects on objectives

Risk management has also primarily focused on the probabilities of risk events. ISO 31000 changed this focus to "the effects of uncertainty on objectives." This does not remove the consideration of probabilities, however, it does move the analysis more on how objectives will be effected by uncertainty.

3. The effects of risks are both negative and positive

Consideration of both negative and positive effects substantially transforms the value of risk management. Analyzing threats and opportunities advances risk management beyond just driving down risk. Instead, it allows risk to be used as an optimization strategy to increase the certainty of achieving outcomes.

4. Risk moves further into operations

Traditional as well as enterprise risk management has until recently focused on extrinsic risk. These are external risks that may impact our business. However, the attention has now moved further into the operations of the business where the focus is on intrinsic risk. Intrinsic risks are those that are internal to our programs, systems and processes. Identifying these may require an increased knowledge of management systems and manufacturing processes to understand how to best prevent threats or enhance opportunities.

Ans(iii)

• Insure assets
• Compliance with fire & building regulations
• Early warning systems e.g. smoke alarms, sprinklers.
• Credit checks
• Set credit limits
• Set payment terms for suppliers
• Use debt collection agency
• Check financial background
• clear vision

Ans(iv)

Financial risk:-

The biggest risks facing many organizations are actually financial. Founders often have invested their life savings or taken out significant loans in order to get the organization off the ground, so there is a lot of pressure to be successful.

Cash flow is one of the biggest concern at the beginning. You must consider where money will come from to maintain operations, pay employees, and invest in market penetration and growth.

Depending on the industry, you may have to make a large upfront investment and it can take a while to begin seeing a return. Careful preparation and planning, as well as support from third parties, can help you mitigate this risk.

Economic conditions are also an important factor to keep in mind. A serious recession can damage even the most wealthy of organizations and are more than able to put a small organization out of business.