INSTITUTE –University School of
Business
DEPARTMENT -Management
MBA
Financial Management Code:23BAT626
Faculty Name: Dr. Richa Sharma
Assistant Professor
Unit -3 Risk
Management DISCOVER . LEARN . EMPOWER
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Introduction to
Corporate Finance
CO
Title Level Will be covered in
Number
the lecture
Remember
To develop an understanding of the basic ,
CO1
fundamentals of financial management Understan
d
To apply the theories of capital structure in
CO2 Apply
managerial decision making
To analyze different project proposals
CO3 Analyze
based on capital budgeting techniques.
To evaluate different working capital
CO4 Evaluate
approaches and their impact on business.
To design an optimal capital structure and
CO5 Create
optimum dividend payout for a firm
Learning Objective
To Understand and concept of risk management in financial
management/ corporate finance.
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What is Corporate Finance?
CF entails the process of planning, organizing, directing, and controlling the
financial activities of an organization. These include the procurement and
utilization of funds for the enterprise. It means applying general management
principles to the financial resources of the organization.
CF is a critical topic in business because companies cannot function without the
proper use of funds. To understand and apply the right financial management
practices in handling and use of funds, one has to have either a professional degree
or online financial management certification.
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The Objectives of CF:
● Profit Maximization
One of the main reasons an organization employs a financial manager is to maximize the profits
whilst managing the finances of the company. The gain can be short-term or long-term. But, the main
focus is the financial manager or department handling the financial issues of the organization must
ensure that the organization in question is earning sufficient profit.
● Proper Mobilization of Finance
The collection of funds required to run the business is also a critical part of financial management that
the manager needs to handle appropriately. Once the finance manager concludes the estimation of the
amount required for a business process, the required amount can then be procured from a legal source
such as debenture, shares or even request for a bank loan. But, the point is that the balance between
the money the firm has and the amount borrowed should be maintained.
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Risk is inherent in any business operation and good risk management is essential if
you're going to identify and stop revenue leakage from your business. Of the
various types of risks your business might face, financial risk has the most
immediate impact on your cash flows and bottom line. You can anticipate these
risks and head them off at the pass with a solid financial risk management plan.
What Is Financial Risk?
Anything that relates to money flowing in and out of the business is a financial risk.
Since the list of potential risks is so long, most analysts place them into one of four
categories as follows:
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Market Risk
As the name implies, a market risk is any risk that comes out of the marketplace
in which your business operates. For example, if you are a bricks-and-mortar
clothing store, the increasing tendency of customers to shop online would be a
market risk. Businesses that adapt to serve the online crowd have a better chance
of surviving than businesses who stick to the offline business model.
More generally and whatever sector you're in, every business runs the risk of
being outpaced by competitors. If you don't keep up with consumer trends and
pricing demands, then you're likely to lose market share.
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Credit Risk
Credit risk is the possibility that you'll lose money because someone fails to
perform according to the terms of a contract. For example, if you deliver goods to
customers on 30-day payment terms and the customer does not pay the invoice on
time (or at all), then you have suffered a credit risk. Businesses must retain
sufficient cash reserves to cover their accounts payable or they are going to
experience serious cash flow problems.
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Liquidity Risk
Also known as funding risk, this category covers all the risks you encounter
when trying to sell assets or raise funds. If something is standing in your way of
raising cash fast, then it's classified as a liquidity risk. A seasonal business, for
example, might experience significant cash flow shortages in the off-season. Do
you have enough cash put aside to meet the potential liquidity risk? How quickly
can you dispose of old inventory or assets to get the cash you need to keep the
lights on?
Liquidity risk also includes currency risk and interest rate risk. What would
happen to your cash flows if the exchange rate or interest rates were to suddenly
change?
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Operational Risk
Operational risk is a catch-all term that covers all the other risks a business
might encounter in its daily operations. Staff turnover, theft, fraud, lawsuits,
unrealistic financial projections, poor budgeting and inaccurate marketing plans
can all pose a risk to your bottom line if they are not anticipated and handled
correctly.
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Types of Risk
Broadly speaking, there are two main categories of risk: systematic and
unsystematic. Systematic risk is the market uncertainty of an investment,
meaning that it represents external factors that impact all (or many) companies
in an industry or group. Unsystematic risk represents the asset-specific
uncertainties that can affect the performance of an investment.
Below is a list of the most important types of risk for a financial analyst to
consider when evaluating investment opportunities:
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• Systematic Risk – The overall impact of the market
• Unsystematic Risk – Asset-specific or company-specific uncertainty
• Political/Regulatory Risk – The impact of political decisions and changes in
regulation
• Financial Risk – The capital structure of a company (degree of financial leverage
or debt burden)
• Interest Rate Risk – The impact of changing interest rates
• Country Risk – Uncertainties that are specific to a country
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• Social Risk – The impact of changes in social norms, movements, and unrest.
• Environmental Risk – Uncertainty about environmental liabilities or the impact
of changes in the environment.
• Operational Risk – Uncertainty about a company’s operations, including its
supply chain and the delivery of its products or services
• Management Risk – The impact that the decisions of a management team have
on a company
• Legal Risk – Uncertainty related to lawsuits or the freedom to operate
• Competition – The degree of competition in an industry and the impact choices
of competitors will have on a company
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What is Financial Risk Management?
Financial risk management is nothing but identifying the potential pitfalls called
risks, prioritizing them, and finding appropriate solutions to mitigate or eradicate
these risks.
Of the various types of risk your organization might face, financial risk has the
most immediate impact on your cash flow and the bottom line.
You can anticipate these risks and head them off at the pass with the help of an
online financial management certification.
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What Is Financial Risk Management?
Financial risk management is the process of understanding and managing the
financial risks that your business might be facing either now or in the future. It's
not about eliminating risks, since few businesses can wrap themselves in cotton
wool. Rather, it's about drawing a line in the sand. The idea is to understand what
risks you're willing to take, what risks you'd rather avoid, and how you're going
to develop a strategy based on your risk appetite.
The key to any financial risk management strategy is the plan of action. These
are the practices, procedures and policies your business will use to ensure it
doesn't take on more risk than it is prepared for. In other words, the plan will
make it clear to staff what they can and cannot do, what decisions need
escalating, and who has overall responsibility for any risk that might arise.
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How Do You Implement Financial Risk Control?
Organizations manage their financial risk in different ways. This process depends
on what the business does, what market it operates in and the level of risk it is
prepared to accept. In this sense, it's up to the business owner and directors of the
company to identify and assess the risk and decide how the company is going to
manage them.
Some of the stages in the financial risk management process are:
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Identifying the risk exposures
Risk management starts by identifying the financial risks, and their sources or causes. A good place to
start is with the company's balance sheet. This provides a snapshot of the debt, liquidity, foreign
exchange exposure, interest rate risk and commodity price vulnerability the company is facing. You
should also examine the income statement and the cash flow statement to see how income and cash
flows fluctuate over time, and the impact this has on the organization's risk profile.
Questions to ask here include:
• What are the main sources of revenue of the business?
• Which customers does the company extend credit to?
• What are the credit terms for those customers?
• What type of debt does the company have? Short-term or long-term?
• What would happen if interests rates were to rise?
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Quantifying the exposure
The second step is to quantify or put a numerical value on the risks you've
identified. Of course, risk is uncertain, and putting a number on risk exposure will
never be exact. Analysts tend to use statistical models such as the standard
deviation and regression method to measure a company's exposure to various risk
factors. These tools measure the amount by which your data points differ from the
average or mean.
For small businesses, computer software like Excel can help you to run some
straightforward analysis in an efficient and accurate way. The general rule is the
greater the standard deviation, the greater the risk associated with the data point
or cash flow you're quantifying.
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Making a "hedging" decision
After you've analyzed the sources of risk, you must decide how you will act on this information. Can you live
with the risk exposure? Do you need to mitigate it or hedge against it in some way? This decision is based on
multiple factors such as the goals of the company, its business environment, its appetite for risk and whether
the cost of mitigation justifies the reduction in risk.
Generally, you might consider the following action steps:
Reducing cash-flow volatility.
Fixing interest rates on loans so you have more certainty in your financing costs.
Managing operating costs.
Managing your payment terms.
Putting rigorous billing and credit control procedures in place.
Saying farewell to customers who regularly abuse your credit terms.
Understanding your commodity price exposure, that is, your susceptibility to variations in the price of raw
materials. If you work in the haulage industry, for example, a rise in oil prices can increase costs and reduce
profits.
Making sure the right people are given the right jobs with the right degree of supervision, to reduce the risk of
fraud.
Performing due diligence on projects, for example, considering the uncertainties associated with a partnership
or joint venture.
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Questions
• Q1) What are risk impact and risk probability?
• Q2) What are the top skills for a risk management role?
• Q3) How do you think about risk when making decision?
• Q4) Why do you think risk management is important for businesses?
• Q5) As a risk manager, how can you ensure monitoring and control of
risks?
• Q6) Do individual performance plans include risk management?
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Blackboard
Assessment Pattern
Components HT-1 HT-2 Assignment Surprise Test Business Quiz GD Forum Attendance Scaled
Marks
Max. Marks 10 10 6 4 4 4 2 40
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References
• Reference book- Maheshwari S.N, Accounting for Management, Vikas Publishing House, New Delhi,2010
• Reference Website: [Link]
• Reference Journal for advance study: Journal of Accountancy (JOA)
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THANK YOU
For queries
Email: richa.e15817 @[Link]