The Hindu Business Line : You can't run away from risks

Risk management can be defined as identification, analysis and economic control of risks that threaten the assets or earning capacity of enterprises.

The Kumaramangalam Committee on corporate governance believes that it is necessary for corporate boards to be aware of the risks inherent in business and for shareholders to know the steps being taken to manage such risks.

Risk is said to exist when there is possibility of deviation from the desired outcome. There are pure and speculative risks, but only the former are insurable.

Pure risks can be classified into personal, property, liability and those arising from the failure of other persons. Premature death, dependent old age, sickness/disability and unemployment are some of the forms of pure risk. Such risks can be reduced by taking life insurance, mediclaim and accident insurance policies. Property risk may be because of loss of property, loss of usage of property or additional expenses occasioned by the loss of property. Such risk can be minimised by taking property insurance.

Liability risk is the unintentional injury to other persons or damage to property through negligence or carelessness. Third-party insurance coverage is available for handling this risk.

There are various methods to handle risk, and these can be categorised as: a) avoiding, b) retaining, c) transferring, d) sharing, or e) reducing. Hence, risk management can be defined as identification, analysis and economic control of risks that threaten the assets or earning capacity of enterprises.

In this backdrop, let us look at the how companies can assess and minimise risks. The Kumaramangalam Committee report discusses the practices corporate managements should adopt to minimise or insulate against global, general, economic, political, industry and other company-specific risks. Earlier, risk management meant taking insurance policies. With globalisation, corporate risk management plays a vital role and, hence, every organisation has to look at the risks they face on various fronts and the strategy required to minimise them.

Global risk

Global risk is dependent on many factors, such as global levels of business and services, GDP growth, technology, change in human needs, restrictions to materials/finished product trade, WTO norms, and so on. For example, if an industry is dependent on petroleum products, then the fortunes of the industry depend on the global availability of petroleum products and their prices. Over time, naturally available resources of fuel could get depleted and, hence, the organisation will have to look at alternative sources.

Industry risk

Industry growth and demand-supply position of a product play a vital role in a company's performance. The industry's demand-supply gap has to be balanced. Further, the demand for the products of some industries are cyclical. Hence, while taking a decision on industry risk, the company should discuss in detail the policy it will pursue to minimise the risk.

Economic risks

Normally, the prevailing economic conditions have a bearing on the demand for products. Adverse conditions will obviously reduce the demand/supply of a product.

Government policy on the economic front can also have a major impact on the demand for a product.

For example, over the past few years, government incentives for infrastructure development and concessional rates of interest for housing loans have resulted in the rising demand for steel, cement and other building materials.

Company-specific risks

The profitability of companies which, for instance, are power-intensive, is closely linked to the Government's power policy. Interruption in power supply and rising power tariffs will affect the fortunes of such companies, and they would do well to explore the possibility of using alternative sources of power, as this is important in minimising business risk.

In information technology companies, "data security" and human resource management are important.

The company should have clear business plans for "data security", by having access control/restrictions and HR policies for recruiting, developing and retaining its personnel.

Raw material availability

Availability of basic raw material is crucial for the sustainability of a company. Companies have to look for alternative sources for uninterrupted supply of raw materials. If it is cheaper to import the inputs, they should enter into long-term contracts for supply of the same.

Logistics

Logistics plays a vital role. Companies should explore all the possibilities to optimise the operations, by having a combination of transportation through road/rail and sea/air. Rather than make use of outside transport sources, organisations should also explore the possibility of in-house a logistic mechanism if the situation demands.

Foreign exchange

A number of companies require imported raw materials, but may not be exporters themselves. In such cases, forex rate changes will have a big impact on profitability. These companies should, to the maximum possible extent, make use of indigenous inputs.

They should also explore foreign markets for its finished products. To insulate against exchange fluctuations, they will have to go in for forex cover for raw materials/finished goods. Though risk cannot be avoided totally, it can be reduced by taking appropriate preventive steps.

(The author is a Chennai-based chartered accountant.)

More Stories on : Corporate Governance | Insight

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Financial independence and a dose of self defence

More services under the tax net

Bulls Eye

Baskets of X

You can't run away from risks

Can this be a quick way to empower people?

Number Crunch

Just Do It

Donors to charities will have to be on guard

There's always a road to success

Business-a-Verse

Five virtues and vices of family businesses

Brain is a great oxygen-guzzler

Cartoons