Risks A.
Strategic – from outside environment, long term effect: o Business risk – decisions on products supplied (Tech. changes, Macroeconomic ~) o Non-business – collapse in trade due to adverse event, natural disaster
B.
Operational risks – day-to-day business, failure of internal business and controls: o internal controls, audit inadequacy, regulations, internal procedures, IT failures, human error, fraud, loss of key person, business interruption
Treats in - Competitors – new products, decrease of price SWOT - - Product – become old-fashioned, need to improve, quality Business - Supply – shortages, increase price risks - Stakeholders – poor relationship - Product – become obsolete - Compliance and regulations - Financial o Structure of finance – debt/equity base in long term, providing finance o Currency Transaction, Translation, Economic (effect on international competitiveness) o Interest o Market – stock, bond price down o Financial records and reports - Trading o Physical (lost), trade (refuse order), liquidity (not pay) - Investment o Wrong assessment, cost of capital, NPV, time horizon, data - Property/physical - International o Trade, credit, tax, FX o Cultural – misunderstanding
o
Political – nationalization o Legal - not meet regulation - Information systems and controls - Fraud - Reputation
Risk management model 1. 2.
Risk appetite – shareholders, management and culture Risk analysis a. Identification b. Assessment – severity, frequency
c. d. 3.
4.
Profiling and prioritisation
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Quantification – loss, frequency, probability...
Risk management –develop response a. Accept b. Transfer c. Control/reduce – contingency plan, back-up d. Abandon, avoid Review and feedback
SEVERITY LOW F R E Q U E N C Y
Assess
HIGH
HIGH Transfer Insure risk. Reduction of severity will minimise the premiums. Abandon or avoid Take immediate action eg changing major
CIMA
RISK MANAGEMENT Identify
LOW
Accept Risks not significant. Keep under review Control or reduce Take some action, eg enhanced control systems to detect problems, to reduce impact
Develop response with respect to appetite
Implementing, and monitoring risk controls and reviewing their effectiveness
Management control systems (MCS) Organisation as a system – SCAN PICTURE PAGE 48
Control – ensuring that activities lead to desired outcome
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Problems of traditional management accounting Timing – 85% of the cost is “defined” at design stage. ↑↓ Accountants however, continue to direct efforts to production stage Controllability – 10 % direct cost and 30 % overhead are controllable in short term. Accounting spend 3 times more on direct cost. Customers – most of the cost driven by them but not recognised by cost accounting. – e.g. after sales, number of transactions, quality issues Costing method – in JIT system, small batches result in thousand s of transactions that serves nothing. Back flush as alternative. Absorption costing – ABC rather than labour hours or machine hours Standard costing – More appropriate in large scale production but less when flexibility or customisation needed Performance indicators properly set – may produce wrong response – if “cost of scrap, return factor” is KPY production may be tide up with reworking (in order to decrease returns) instead of trying to “get it right first time” Investment appraisal – problem with assumptions Control systems - Single and double loop - Feedback and feed forward - Management accounting control - scorekeeping, directing attention, used for problem solving o Standard cost accounting o Cost allocation – ABC, machine hours o Lean accounting – focus on value and waste of recourses o Lifecycle costing o Target costing o Back-flush costing o Investment appraisal - Controlling H Recourses - Budget and budgetary control - Balanced scorecards
INTERNAL CONTROL SYSTEM
Internal controls policies and on procedures to ensure Control environment – Attitude of the :management significance of control: values style structure responsibilities
effective and efficient conduct of business: Safeguard of assets Regulatory compliance Prevention & detection Fraud and Errors Accuracy and completeness of accounting Timely and reliable financial information
Internal controls – example Financial - Variance analysis - Stock recording system - Fixed assets register Non-financial - Customer satisfaction - Employee turnover - Product wastage Non-financial qualitative - policies and procedures - physical assets control - structure of authority and reporting - HR controls – contracts, job description, performance appraisal -
Good INFORMATION - Relevant - Accurate - Reliable - user confidence - Timely - Well communicated - Cost – effective Management accounting information - Forward–looking - Fin and Non-financial - Free from bias - Comparative
Corporate governance – system by which organizations are directed, managed and controlled Features of poor corporate governance: a) Domination by a single individual: b) Lack of involvement of board: c) Lack of adequate control function:. d) Lack of supervision. e) Lack of independence – auditors not independent: f) Lack of contact with shareholders: g) Emphasis on short term profitability h) Misleading accounts and information: Benefits of good corporate governance: a) Reduces risk b) Shows transparency/accountability c) Stimulates performance d) Improves access to capital markets e) Good PR to all stakeholders f) Imposes leadership Directors and Board - issues - Chairman <> CEO - Board balance - Non-executives, independence fro operations, balanced position - Responsibilities and role o Non-executives – Strategy; Performance; Risk; Directors – remuneration and change - Remuneration – dependent on performance, clear policy Internal control and Audit committee - Participation of independent non-exec. - Responsibilities: o Review of financial statements and systems o Liaison with external auditors o Review of internal audit and auditors o Review of internal controls o Risk management policy review
Internal audit Audit committee – helps the board, review risk policy and internal controls Objectives - Risk policy and strategy review - Accounting system review - Internal controls review - Review finance and operational information - Compliance review – law, regulations, internal procedures - Safeguarding of assets - Implementation of corporate objectives – review Type of audits - Accounting system - Operational system - Value for money - Management audit – examine management performance - Social &Environment audit - Transactions - Systems - Risk-based audits - Internal - External
Financial risks Type of risks -
SHORT Financial structure Credit risk Liquidity Cash management
LONG - Currency - Interest rate
Quantification - Sensitivity analysis and NPV - Certainty-equivalent cash flows approach – cash flows * probability - Expected values – forecast * probability - Standard deviation of NPV – higher deviation – higher risk - Value at risk – maximum loss at given probability level - Regression analysis - Decision tree and matrix - Scenarios
Exchange / Currency RISK
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Economic risk – exchange rates impact competitiveness o Match assets and liabilities (loans) o Diversify suppliers and customers o Diversify world-wide
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Transaction risk – adverse exchange rates movement o Matching receipts and payments o Invoice in own currency o Leading and lagging of payments o Netting receivables and payables o Forward contracts o Money market hedging – borrow in foreign currency o Futures and options - Translation and accounting risk o Not a cash flow
Futures vs Forward + Lower transaction cost + Exact date not have to be known + Available to smaller companies, no credit rating required + Can be closed at any time - Contract can not be tailored nor negotiated - Inefficiency – size and time standardized, basis risk (backwardation) - Limited number of currencies - For both non-USD currencies – procedure twice complex
Options vs Forward and Futures + Possible profit + Support tenders + Where uncertainty exist - Additional premium cost - Premium paid immediately - Not negotiable - Not in every currency
International risks Trading & Credit risk -
Physical Credit Trade – customer refuse to accept goods Liquidity – not able to finance the creit FX
Exchange / currency risk – discussed above Cultural risk Political risk -
Quotas Tariffs (import, export) Legal standards (non-tariff barriers) Nationalization Min or max shareholding Exchange control – blocked funds, limit in-out transactions
Legal risk -
Export/import control through bureaucratic procedures (environment, health…) Favorable trade status e.g. EU Monopoly and mergers legislation Law of ownership – e.g. majority of local shareholders Taxation law – discourage import / export International trade mark acceptance, intellectual property recognition Pricing regulations
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