Management of Risk – An Art or a Science?

BUSINESS RISK is a term that explains the difference between the expectation of return on investment and actual realization. In CAPITAL BUDGETING, several alternatives of investments are examined before taking an investment decision and only then the Director Director of the firm along with financial executives gear up for investing in a project that is sound and feasible. Even then the project may not become viable and may not work to our expectations due to the fluctuations in the economic environment.

So, the million dollar question arises, Whether to invest and if invested, will it fetch me profit? See, you can not have the cake and eat it too. Risk factor prevails in all kinds of environment and we try to over react in a business arena since it involves huge investments. But remember, MONEY WILL MULTIPLY IF YOU MANIPULATE IT WITH CARE.

Business firms commit large sums of money each year for capital expenditure. It is therefore essential that a careful FINANCIAL APPRAISAL of each and every project which involves large investments is carried out before acceptance or execution of the project. These capital budgeting decisions generally fall under the consideration of the highest level of management.

Factors of risk to be considered before investing:

  • Time value of money
  • Pay back period
  • Rate of return on investment (ROI)
  • Uncertainties in the market
  • Cost of debt
  • Cost of equity
  • Cost of retained earnings

Factors to be monitored after investing:

  • Maximizing profit after taxes
  • Maximizing earnings per share
  • Maintain the share prices
  • Issue of disputes
  • Ensuring management control
  • Financial structuring

Cost of capital reimbursers to the opportunity cost of the funds to the firm ie, the return to the firm had it invested these funds elsewhere. Thinking businessmen like RATAN TATA, DHIRUBHAI AMBANI and the like have also mastered the art of capturing the market by INNOVATIVE THINKING THAT PROVIDES GOOD TO THE MASSES.

While making the decisions regarding investment and financing, the Finance Manager seeks to realize the right balance between risk and return. If the firm borrows heavily to finance its operations, then the surplus generated out of operations should be sufficient to "SERVICE THE DEBT" in the form of interest and principal payments. Th e surplus would be greatly reduced to the owners as there would be heavy Debt Servicing. If things do not work out as planned, the situation becomes worse, as the firm will not be in a position to meet its obligations and is even exposed to the " DANGER OF INSOLVENCY ".

Considering all these factors, we have to come to the conclusion that FINANCIAL MANAGEMENT is like the BACKBONE of a business firm and WORKING CAPITAL MANAGEMENT will be the blood flow infused into the body. Risks arise ONLY IF WE MISMANAGE, otherwise in a business everything goes as planned and I feel that luck does not favor anyone who is poor in planning and not ready to work hard.

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