Smart Risk Management: A Guide to Identifying and Calibrating Business Risks
Management accountants must be able to define the payoffs from their organisation's risk taking, as well as identify, understand, and reduce the negative effects of everyday business risks. This book defines organisational risk taking and outlines a formal process to handle risk effectively.
The book details six steps for sound risk management:
- Defining risk
- Examining your attitude toward risk
- Analysing your organisation's ability to handle risk
- Minimising a risk's exposure or downside
- Recovering quickly from a risk's negative impacts
- Expanding your knowledge so you can accept more risk with confidence
Written for management accountants, mart Risk Management analyses your position in the middle of the organisation-ensuring both that it does not take risks whose costs it cannot afford and that it takes enough risks to stay competitive in the evolving marketplace.
Having adequate insurance coverage is only one small piece of risk management, as this book explains. With ample examples and case studies, as well as 50 hands-on risk tools, Smart Risk Management will enhance your understanding of strategic, operational, and innovation risk and increase your value to your organisation.
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Your Business Plan Risk
A company’s business model is made up of two components:
1. The organisational structure and processes
2. The impact on operational risk from decisions made
In addition, if an organisation is unable to perform or execute its strategy, the firm incurs execution risk. To assess and measure execution risk, a company focuses on the results it generates from the structure of its marketplace and its business model. Within the theory of your business model, three specific global risks reside:
1. Strategic risk
2. Operational risk
3. Innovation risk
Strategic risk is defined as the inability to align with competitive pressures and customer sufficiency. Falling under the threat that you cannot carry out your strategy are eight risk categories:
1. Operational risks (execution of your strategy and goals)
2. Reputation risks (impact on your reputation and brand)
3. Financial risks
4. Hazard risks
5. E-commerce and technology risks
6. Intellectual capital risks
7. Ethical risks
8. Integrity risks
Risky Strategy Leads to Ethical Risk
Strategic planning is managing change and overcoming risks. It is a critical process through which risks can and need to be identified and dealt with in advance.
For your firm to manage your strategy risk, the leaders must develop acceptable expectations for all products or services. A risk to your firm’s ethical standards is involved in this process, because there is intense pressure on the organisation and the employees to meet a lofty goal, to achieve its business plan, and to satisfy creditors or investors. The more this pressure is applied, the more likely people will undertake unwarranted risk. If these wild, out-of-control leaps fail or do not achieve the high expectations, there is urgency for people to cover them up. Thus, your integrity is at risk.
Risky Market Leads to Integrity Risk
In market risk, firm integrity is involved and can be damaged when your research or studies are flawed or when your assumption of the customer’s needs is skewed in favour of the organisation. Many market studies have been accepted as true without consideration of the realities of the marketplace or not obtaining true customer buy-in. Facing this risk requires you to get your input about the competitive environment from the source.
Risky Capability Leads to Integrity Risk
The capability or internal risk is another place where extreme pressure is felt when it is clear you will not achieve your goals. It is important to challenge people’s ability and to test their capability to expand and improve. However, leader hubris combined with undue pressure often manifests when you over-promised and must now under-deliver. People will want to massage the numbers, to make up data, and of course, to hide the internal faults. This last trait leads to buck-passing and blaming. These behaviours, of course, negatively affect the profits and damage integrity. The net result is bad news for all.
Operational risk management looks at the business from the operation itself and is defined as the risk of direct or indirect loss resulting from inadequate internal control, processes, people, and systems to react to external events. Financial information is not enough to gauge a company’s overall business risk.
The value of managing operational risk is only slowly gaining recognition. One reason is that by the time the financial impact of management’s misjudgement affects the balance sheet or income statement, it is typically too late to do anything about it other than pick up the pieces. By tracking operational indicators and metrics, leaders can identify opportunities and threats before they affect the company’s finances.
One approach to measuring operational risk requires firms to routinely review many nonfinancial factors such as the quality of corporate governance, employee morale, customer satisfaction, implementation of goals and execution of those goals, the company’s application of technology, and its deployment of those practices. Numerous tools that enable you to easily measure operational risk already exist, such as the balanced scorecard, activity-based costing, or driver-based forecasting.
Budgeting Hampers Operational Risk Identification
Most companies still rely on planning and budgeting process and reporting techniques that may have been created decades ago. To improve the likelihood of detecting operational risk, organisations can do the following:
• Update their technology
• Use advanced analysis tools
• Apply for ISO 9000
• Use a balanced scorecard reporting system
• Incorporate activity based costing
• Invest in an enterprise-wide accounting system
Managing operational risk requires a systematic, objective, and comprehensive framework that assesses all of the nonfinancial variables that could contribute to an organisation’s risk portfolio.All firms incur certain operational risk simply when choosing their marketplace and its customer base. Business complexity and revenue volatility are directly affected by the structure of the market. Technology, regulations, the consumer, and the global economy all drive changes in market structure. All of these must be factored into the assessment and valuation of your operational risk.
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