By Dr B K Mukhopadhyay
The world today has become more complicated – so also global fincial markets -much more uncertain than ever before. The global fincial uncertainties were not entirely unticipated but, yes, the intensity was not predicted nor was the duration expected and the outlook is far more uncertain now for global situation than before. The declining situation in Euro Zone; the global fincial turmoil emated from the us sub- prime mortgage crisis; topsy turvy oil prices ; changing gold prices – a few instances out of a good equilibrium / peace disturbing numbers – then and now - clearly show the need for guarding against uncertainties weighing properly the ability to absorb risk!
Business risk and fincial risk are the two important terms with which the entire business world has been well acquainted.
Business risk is experienced by small, medium as well as large firms, which, in turn, is governed by generation of fund to run the operations of the firm on a regular basis.
While business risk deals more with the strategic decisions of a company, fincial risk is related to the monetary aspects and debt - related to the structuring of the finces of an organization.
Business risk is more related to the decisions related to the smooth and profitable functioning of an organization. On this score: entering into an entirely new business, buying stake in a company, reducing the stake in a company, introducing new products in the market are the important aspects related to the business risk. Certainly, the business risk is also associated with the issues regarding getting returns on assets of the company, the variability in demand for its products, variability in the input cost, operating leverage, variability of sales price are the vital factors which determine the business risk of an organization.
Clearly, fincial risk will vary with the ture and type of investment - risk increases greatly when a certain organization decides to use debt from fincial institutions for business expansion along with equity fincing. In fincial risk, it is the structure of interest rates that comes to the fore - any rise in the interest rates of your business can affect cash flows. Ever changing foreign exchange rates also add to the fincial risk for a company and as such fincial risks in intertiol business are much more than those involved in domestic business.
An idequate awareness as to the intertiol markets can significantly increase this fincial risk.
In fact, risk is where the business is. Business without risk is just like preparing omelets without breaking the egg! So, it is wise to accept that since one is in the business risk chases like a shadow. The question is not to elimite it, but to minimize the same. That is to say in this 21st century business it is all about mitigating the risk and as such the age belongs to successful risk magers who could locate, measure, control and mage the risks over a period of time. As such a business risk refers to is a circumstance or factor that may have a negative impact on the operation or profitability of a given company. A business risk [sometimes referred to as company risk] can be the result of interl conditions, as well as a number of exterl factors [beyond the control of the company to correct] that may be evident in the wider business community.
Keeping in view the recent global experience on fincial crisis the urgent requirement is to examine the very adequacy of risk magement system that is being followed. Risk minimization efforts occupy the central place in such a vital context. - mechanism followed to minimize liquidity risk; use of GAP Alysis and other mechanism to measure and mage interest rate risk and the mechanisms to minimize foreign exchange risk is to be looked into, especially among others. Institutions are to assess the effectiveness of risk-conscious interl control system.
In fact, this are calls for assessment of the vital aspects like: effectiveness of the audit committee; effectiveness of the interl Audit Function; rectification of the deficiencies identified in the audit reports; adequacy of the controls in credit operation / controls exercised; adequacy of the controls in Treasury operations, adequacy of the controls in Branch operation; adequacy of the controls in procedures related to expenditure as well as adequacy of the control over fixed assets.
Needless to say here: corporate Governce area invites proper attention on : formulation and implementation of required plans, policies and guidelines, code of conduct of directors, Chief Executive and Employees, mechanism to identify related parties, promoters, directors or senior magement and lending to directors, chief executive, employees(except as per employees rules) and their related parties, if any.
The need is here to mention other related aspects: adequacy of the Magement Information System (MIS), control in information Technology and related support function; reliability of mechanism used for reporting plus accuracy of such returns; compliance with the prevailing Statute, Act, Directive and Regulations, especially in vital areas like : profit appropriation to general reserve: appropriation to exchange fluctuation reserve, distribution of dividend and of course whether prohibited activities are pursued.
In fact: fincial sector policies and instruments are required to be constantly rebalanced to respond not only to fincial markets, prices and overall stability considerations but also to developments in real sector especially , trends in growth across sectors, regions and sections of population. The need is there for an inorganic growth in order to compete with the techno-reinforced foreign banks on Indian soil.
To generate income to meet challenges thrown by the steady entry of the foreign players alterte ways are to be tapped since it is crystal clear that tinkering around the already travelled areas cannot give rich dividends simply because of the fact that the call of the contemporary age relates to pure business and nothing else – a highly complex situation where keeping pace with demand is itself a much harder task compared to even a decade back. Talent and people development emerges to be the biggest challenge for the business world, especially for the new incumbents.
Then there is another risk – concentration risk. Concentration may arise in a particular market, industry, region, tenor or trading strategy. It is well known that diversification is one of the cornerstones of risk magement. Just as professiol gamblers limit their stakes on any one hand to a small fraction of their net worth so as to ensure that they won’t be ruined by a run of bad luck, so also a professiol risk-taking enterprise has to limit the concentration of their exposures to prevent any one event having significant impact on their capital base.
Unfortutely, there remains a tural tension between pursuit of an institution’s core competencies and competitive advantages into profitable market segments or niches that produces concentration, and their desire to diversify and exposures!
Needless to mention that the main risk which all kinds of businesses face is that of the under performance of the economy of a tion - the time when economic growth slows down business will grow at very slow pace or may even come to a sudden halt! The risk that a firm will go bankrupt [mainly because of lack of payment of debts] is also one of the big business risks. Added to this: competition with peer companies is one of the major business risks faced by entrepreneurs.
Obvious enough: competition can force business houses lower the rates of their products, which, in turn, can result into lesser revenues and net profits. Competition also causes a fall in the market share of the company due to the entry of new products. Is it not a fact that poor magement is a business risk, which, of course, can be avoided by changing the board of directors? Filly, enterprise risk magement can be learned only after gaining sufficient experience.
Good risk magement abilities are a must to take any business – big or small - to the top.
(The Writer, a noted Magement Economist, an Intertiol Commentator on ongoing Business and Economic Affairs, Director Netaji Subhas Institute of Business Magement, Jharkhand, can be reached at firstname.lastname@example.org.)