CHAPTER 1: INTRODUCTION

Financial risk management is a process that describes the practice of identifying, measuring, and
controlling the financial risk carried by an organization. Note that we describe financial risk management
as a both a process and a practice. A process is an ongoing activity. One cannot simply set a process in
motion and let it go. There is no autopilot setting in financial risk management and in most other
processes. Financial risk must be actively and continually managed. Financial risk management is also a
practice.
Professionals such as physicians, dentists, and attorneys are said to practice their professions.
This characterization recognizes and implies that perfection is never achieved, but that serious
professionals are constantly honing their skills by facing different scenarios that require their
knowledge, judgment, and experience. This is indeed what good financial risk management
entails.
Notice also that we described financial risk management in terms of three activities:

1.1 Identifying risk

1.2 Measuring risk
1.3 Controlling risk

These actions combine to form the process of managing risk. First, we can hardly
manage risk if we do not know what risks we have. Hence, we must identify the risks.
But identifying risk does not mean one knows how much risk there is. For example, a
person with a family history of colon cancer would probably know that he has a greater
than average risk of contracting the disk.
But how much greater than average is this person’s risk? On average one out of every 20
people will get colon cancer in their lifetimes. Is this person’s risk two out of 20? Three
out of 20? Good risk management in health and in finance requires knowing how much
risk there is. And knowing what the risk is and how much risk there is does not mean
controlling it.
The person with the high risk of colon cancer could choose to eat a low-fat diet and get
frequent examinations as a means of controlling this risk. Or, as all too many do, he
could hope that the bad luck will bypass him, a poor risk management strategy indeed
with a very costly penalty if an adverse outcome occurs.
Identifying, measuring, and controlling financial risk are the primary top- down activities
of financial risk management. There are other activities, some that come before, some that
come after, and some that come in between. In this course we will study these activities in
great detail later in this book. Risk management” helps an organization to identify,
evaluate, analyze, monitor, and mitigate the risks that threaten the achievement of the
organization’s strategic objectives in a disciplined and systematic way (note the words
“disciplined” and “systematic”).
Although often viewed as defensive, risk management is a valuable offensive weapon in the
manager’s arsenal. In the quest for preferred outcomes, such as higher profit, returns, or share
price, management does not usually get to choose the outcomes but does choose the risks it
takes in pursuit of those outcomes. The choice of which risks to undertake through the
allocation of its scarce resources is the key tool available to management. An organization
with a comprehensive risk management culture in place, in which risk is integral to every key
strategy and decision, should perform better in the long-term, in good times and bad, as a
result of better decision making.
This executive summary presents the findings from two research projects on risk management
which were funded by grants provided by CIMA. The first grant was for a pilot study
comprising four mini-case studies. Our major focus in that study was on how risk impacted
upon budgeting. The second grant was for a comprehensive survey and analysis of risk
management in organisations and in particular how risk management impacted on both internal
controls and on the role of the management accountant. Following the statistical analysis of the
survey, interviews were conducted with survey respondents and risk management professionals
in order to help us explain our findings. This summary therefore provides the results of these
three phases of our research.
• A review of the practitioner and academic literature as it affects governance,
risk management and management accounting.
• The four exploratory case studies.
• A comprehensive description of the survey design and results.
• Excerpts from the interview data in relation to the survey results.
• A summary of the research findings
• Implications for best practice.
• Risk Management is Important to Financial Accounting

Financial managers make decisions about how to acquire and allocate an organization’s
financial resources. These decisions are traditionally thought of as involving the analysis of
long-term assets (typically called capital budgeting), short-term assets (cash and working capital
management decisions about how much debt financing relative to equity financing to use (the
capital structure decision), as well as how much to pay in dividends (the dividend decision).
Financial managers also make decision about mergers and acquisitions, executive and employee
compensation, the sale of securities through investment bankers, the arrangement of bank loans
and issuance of commercial paper, international financial management problems, and
operational planning and forecasting. Virtually all of these decisions are made facing
considerable risk. But it has not been until recent years that risk has come to be viewed not
simply as a factor that guides these decisions but as something to be actively managed. The
closest financial managers have typically come to this view of financial risk management is in
dealing with exchange rate fluctuations. The new approach is to view risk as a subject in itself,
worthy of study and analysis in the context of financial management. To many financial
managers, risk may seem like the proverbial 800-pound gorilla, a dangerous beast that must be
harnessed and controlled in order that financial decisions can be correctly made. But in fact, risk
can never be mastered, harnessed, or completely controlled.3 In fact, managing risk is
somewhat like shooting at a moving target. Not only is there risk itself, but the risk can even
change, something one might call the risk of risk. But that does not mean one can do nothing
about risk.
Like shooting at a moving target, steadiness and a feel for how the target moves can
improve one’s aim. Building the knowledge and skills to manage risk will, therefore, make
it much easier for a financial manager to make good decisions about capital budgets,
working capital, and other such matters.
But having invested all of this time and energy into learning financial risk management, one
must wonder whether it will really be worth it. Because you have probably had a previous
finance course, you have likely learned that financial markets are pretty competitive. No one
can predict what will happen in the financial world. In that case, why is it worthwhile to do
something such as hedge the risk of adverse movements in exchange rates? Does it really
matter? No one can foresee where exchange rates are going. If one eliminates the risk, isn’t it
as likely that a favorable move will occur as an unfavorable one? Is protecting against risk
really worthwhile? As you will learn in this book, financial risk management can add value.
Exactly how it adds value, however, is a somewhat controversial topic. Some economists
claim that it can enable an organization to improve its credit rating, stabilize its cash flows,
and, if it pays taxes, to reduce its Again, that is why risk management is practiced, realizing
that perfection is unachievable. Taxes. The controversy lies in whether these conceptual ideas
provide clear measurable benefits. We will discuss this point in more detail in Chapter 6.
But more than anything else, financial
risk management can enable an organization to bear the risks it wants to bear and should be
bearing and avoid those it should not bear.

For example, airlines face many risks but the primary one is uncertainty in the price of jet fuel.
Airlines are not energy companies; they are simply big consumers of energy. They have no
competitive advantage in the energy market, at least not in the way an energy company might.
Airlines have a competitive advantage in the market for the services — the demand for and
supply of passengers and transportation of cargo. One does not have to look hard to see that
successful airline, such as Southwest Airlines, have an extensive program of hedging their fuel
costs on a fairly regular basis, while unsuccessful airlines hedge only sporadically or only a
portion of their needs.4 Successful global pharmaceutical companies like Merck, Phizer, and
Eli Lilly have extensive exchange rate hedging programs that protect the value of their foreign
currency cash flows, which provide the funds to support their research and development of
new drugs. They actively take risks in the markets for their products, but they avoid risks in
exchange rate markets, where they have no competitive advantage in forecasting the future. In
doing so, they add value for their shareholders. And adding value is what good financial
decision making
is all about. A 2019 report by Accenture indicated that new investment risks are emerging
with unprecedented speed. The top three new challenges appointed by specialists were
disruptive technology, data breaches, and operational risks. Moreover, climate change has
become a factor to be considered as property, infrastructure, and land damage pose new
challenges.

The 2007 recession in the USA was caused by a combination of the housing boom of the early
2000s and low-interest rates, which resulted in investors offering home loans to individuals
with insufficient credit. Their eventual inability to pay such loans led to a real estate
meltdown, which caused an economic collapse, one of the worst the country (and world) has
seen.
This is only one example of how financial decisions can affect people’s lives at a national or
even global level. There are many other factors today that put responsible financial managers
in high demand…One second thing that people might ignore about “risk” is that some risks
also represent an opportunity. Indeed, risk is often symmetric: if you have risk, you must also
have an opportunity. Is this always the case? If we think about financial risks such as credit,
market and liquidity risks, this should indeed be the case. Financial institutions typically get
exposure to financial risks voluntarily. Why is that? The answer is quite straight forward: “to
enjoy risk premiums”. Market practitioners have an expression for this: there is no free lunch.
In financial markets, if one wants to eliminate risks, the return obtained will be the risk-free
rate. For financial institutions well able to perform the job described above in selecting risks,
the risk premiums might offer attractive opportunities. This is why risk management is so
[Link] management is also important since some risks are undesirable to the extent
that they do not bring opportunity. If we think about the risk of an accident for an airline
company, none would be ready to accept s risk. For financial institutions, the equivalent is
called“operational risk”. This has been defined by the Basel

Committee as “the risk of loss resulting from inadequate or failed internal processes, people,
and systems, or from external events”. While exposure to financial risks might be rewarded by
a risk premium, operational risk is only a cost. And it is hard to eliminate. Like companies
involved in industry and transportation, financial institutions have to build a sound
infrastructure to manage human errors and fraud. Audits and controls are thus important. But
as at least as important is the fact that the firm can trust the people under its responsibility.
As risk management experts

use to say “firms should build a risk management culture”. This represents values, knowledge
and competences shared by people involved in the conduct of business throughout the company.

A 2019 report by Accenture indicated that new investment risks are emerging with
unprecedented speed. The top three new challenges appointed by specialists were disruptive
technology, data breaches, and operational risks. Moreover, climate change has become a
factor to be considered as property, infrastructure, and land damage pose new challenges.
The 2007 recession in the USA was caused by a combination of the housing boom of the early
2000s and low-interest rates, which resulted in investors offering home loans to individuals
with insufficient credit. Their eventual inability to pay such loans led to a real estate
meltdown, which caused an economic collapse, one of the worst the country (and world) has
seen.

This is only one example of how financial decisions can affect people’s lives at a national or
even global level. There are many other factors today that put responsible financial managers
in high demand…Sustainable economy

While some may believe financial risk pertains only to high-ranking CEOs and investors, it’s
essential to understand how it affects everyone. A country’s population is entirely
interconnected through its financial system, and poor financial decisions can lead to an
unreliable market and a declining economy. Having a reliable financial market means a stable
and sustainable economy, in which everyone will benefit from better living conditions.

Solve climate change risks

As mentioned, the reality of climate change can affect businesses and investments in many
ways. Besides the physical risks of property damage, business disruption, and the need for
relocation, factors like technological transition and policy changes need to be considered in a
risk analysis.

However, the full scope of how climate change affects the economy is still unknown.
Specialists believe the economic impact of climate change will only intensify over the
following years, meaning that future professionals may encounter a very different scenario
However, the full scope of how climate change affects the economy is still unknown.
Specialists believe the economic impact of climate change will only intensify over the
following years, meaning that

future professionals may encounter a very different scenario from the one we see today.
Cybersecurity Cyber risk is the number one threat to the global financial system, says U.S.
Federal Reserve Chairman Jerome Powell. Financial institutions are prime targets for
cyberattacks, and sector leaders have appointed cyber security to be at the top of their
priorities, rising above every other potential risk. Risk managers need to develop strategies to
effectively deal with the cyber threat in a world that relies on technology to keep the global
economy afloat.

Cryptocurrencies
The recent boom in cryptocurrency assets can directly affect the overall financial system. A
report by the Financial Stability Board has highlighted vulnerabilities in the crypto market,
such as linkages with the regulated financial system, liquidity mismatch, and credit and
operational risks. Blockchain intelligence companies have invested in risk management
technology, but this remains a sector that will need to be followed closely as it further
develops.

Geopolitics

Not many companies fully consider how geopolitics involves a variety of financial risks.
Access to natural resources, proximity to countries in conflict, limits on foreign relations,
corruption, and local culture are just some factors to consider in a risk analysis. Each location
provides a particular financial scenario, and only by fully understanding this context can a
business use it to its advantage.

Work opportunities

A specialized professional in financial risk management is necessary for every business. Many
companies hire consultants or teams to anticipate exposure, quantify the risk, and plan
mitigation strategies. As a risk specialist, you can work in sales, trading, marketing, banking,
and many other sectors, while benefiting from the increasing demand for qualified
professionals in the field.

In this section, we try to provide an idea about the basics concepts of risk management based
on the literature review. This includes a generic definition of risk, risks management and their
method.

The risk

The thematic of risk management is not new, but it is recent and not very studied in logistic
chain (or supply chain), the first work that explicitly addresses for the risk management in the
supply chain dating from 2003. The risk is present in many activities including the logistic in
which one consequence of the risk that it is increasing and affect around all the logistic
networks, therefore the managers need to make a great deal of effort to identify and manage
risks. The meaning of risk can be differ from one person to another depending on their point
of views, attitudes and experience what makes the study of risk more and more complex.
Aven, proposed a basic risk theory based on brief selected review that over the last 15-20
years and he presented the evolution of risk concept in Oxford English Dictionary since 1679,
we think that definition followed the environment evolution. Veland and Ave, proposed the
same based classification of risk given by Aven and they used theses definition to discuss how
the risk perspectives influence the risk communication between the decision-makers, the risk
analysts, experts and lay people. Indeed, for Karimiazari et al, engineers, designers and
contactors view risk from the technological perspective, lenders and developers tend to view it
from the economic and financial side.
So, the question is: what is a risk? The first answer, the risk is the probability that an event or
action may adversely affect the organization. For Mazouni, the risk is an intrinsic property of
any decision, it is measured by a combination of several.
Factors (severity, occurrence, exposure to, etc.), although it is generally limited to two factors:
severity and frequency of occurrence of a potentially damaging accidents that incorporate
some exposure factors. In the BS OHSAS 18001 (British Standard Occupational Health and
Safety Assessment Series), the risk is a combination of the likelihood of an occurrence of a
hazardous

event or exposures to danger and the severity that may be caused by the event or exposure. In
this context (BS OHSAS 18001), the concept of risk asks oriented questions:
How severe would the impact on health and safety be if the hazardous event or exposure
actually occurred?
The risk can be defined as an uncertain event or set of circumstance which, should it occur,
will have an effect on achievement of one or more objectives. For Marhavilas et al, the risk
has been considered as the chance that someone or something that is valuated will be
adversely affected by the hazard, where the hazard is any unsafe condition or potential
source of an undesirable event with potential for harm or damage. For Bakr et al, the word
“risk” means that uncertainty can be expressed through probability. We can concluded that
the risk is an probabilistic event that can exist
and affect the activity of an organization positively (opportunity) or negatively Data and
research methods

A literature review is a systematic, reproducible, and explicit way of identifying, evaluating,

and synthesizing relevant research produced and published by researchers. Analyzing
existing literature helps researchers generate new themes and ideas to justify the
contribution made to literature. The knowledge obtained through evidence-based research
also improves decision- making leading to better practical implementation in the real
corporate world. As Kumar et al and Rowley and Slack recommended conducting an SLR,
this study also employs a three-step approach to understand the publication pattern in the
banking area and establish a link between bank performance, regulation, and risk.

Financial Accounting: What is it, Importance and Examples

You’ll be forgiven for thinking financial accounting is a complicated topic, reserved for
accountants, analysts, and general number crunchers. Although it can be complex at times, it’s
an important subject that all professionals need to understand to ensure compliance and
profitability. In this post, we’ll take the mystery out of financial accounting, using easy-to-
understand examples to explain what it is and why it’s important
What is financial accounting?
In simple terms, financial accounting is the practice of accounting for all money going in and
out of an organization. It involves recording, classifying, summarizing, and analyzing all
financial transactions.
Recording – Transactions are recorded as either a debit or a credit. When funds come into a
business, that’s a credit. And when they go out, it’s a debit.

Classifying – There are several categories used to determine types of transactions:

Revenue. This is generally from the sales of goods or services. Expenses. These are business
costs, like salaries, office rents, and services
Assets. This is the value of what a business owns. Assets may be physical (known as
tangible), like property and equipment. Or non-physical (known as non-tangible), like a
database of clients and software patents – think intellectual property.
Liabilities. This is what a business owes. It’s not just debt, but also forecasted outgoings.
Examples include mortgages, payroll, and payments owed to suppliers.
Equity. This is what’s left over after deducting liabilities from assets. It’s what the business
owner and shareholders own.
Summarizing – The transactions are summarized into different reports (we’ll look at this later in
the post)
Analyzing – Data and information is analyzed to help make business decisions
There are two different types of financial accounting: cash and accrual. Cash accounting is
generally only used for employee cash expenses, such as client meals and travel costs.
Accrual accounting is all-encompassing and accounts for all business transactions.
What are the principles of financial accounting?
The practice of financial accounting is based on a series of principles, with the five major ones
being:
Revenue principle – All income to a business is recorded when a client or customer accepts the
goods or services – not necessarily when they pay for it.
Expense recognition principle – All expenses are recorded when a business confirms goods or
services from a third party – not when they’re billed for it.