Managing risk There are many techniques available to manage risk. Some look to manage overall risk, whilst others target specific risks. Avoiding risk Some risks can be totally avoided. If a business has identified that opening a subsidiary in Austria appears high risk, then not opening the subsidiary solves the problem!
However, to totally avoid a business opportunity is often a rather extreme reaction – and if no risks are taken, the chance of returns being earned is small! Reducing risk
Overall Risk Reduction Risk is the uncertainty caused by variable returns. One way to deal with uncertainty is to
By operating in many different sectors, it is likely that when one sector is performing badly, another will be doing well, leading to a diversify. smoothing of profits. Advantages of Diversification ● Smoothing of profits, making forward planning easier
● May be economies of scale between some sectors, however diverse those sectors are. Disadvantages of Diversification ● Spreading resources and knowledge too thin
● Being reasonable at many things, but not particularly good at any of them, can smooth returns, but at a relatively low average return
● Investors may question the strategy
● Harder to control the business as it grows in size
● Maybe diversification should be left to shareholders…
● Diversification works best where the business areas are
Risk Pooling negatively correlated – and this means they are usually very different sectors where the ability to get economies of scale, share knowledge etc. may be limited. In some areas of a business, risks can be reduced by centrally managing transactions and looking for possibilities to offset positions.
A centralized Treasury function can manage cash inflows and outflows throughout a business, matching cash surpluses in one sector with cash deficits in other parts
However, to totally avoid a business opportunity is often a rather extreme reaction – and if no risks are taken, the chance of returns being earned is small! Reducing risk
Overall Risk Reduction Risk is the uncertainty caused by variable returns. One way to deal with uncertainty is to
By operating in many different sectors, it is likely that when one sector is performing badly, another will be doing well, leading to a diversify. smoothing of profits. Advantages of Diversification ● Smoothing of profits, making forward planning easier
● May be economies of scale between some sectors, however diverse those sectors are. Disadvantages of Diversification ● Spreading resources and knowledge too thin
● Being reasonable at many things, but not particularly good at any of them, can smooth returns, but at a relatively low average return
● Investors may question the strategy
● Harder to control the business as it grows in size
● Maybe diversification should be left to shareholders…
● Diversification works best where the business areas are
Risk Pooling negatively correlated – and this means they are usually very different sectors where the ability to get economies of scale, share knowledge etc. may be limited. In some areas of a business, risks can be reduced by centrally managing transactions and looking for possibilities to offset positions.
A centralized Treasury function can manage cash inflows and outflows throughout a business, matching cash surpluses in one sector with cash deficits in other parts
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