Companies should be managed so that they do not go into financial distress. Benjamin Graham tells conservative investors not to invest in a company that made a loss in the last ten years.
Financial distress is associated with having operating cash flows fall below minimum required levels. Risk management can reduce the likelihood of low cash flows and hence of financial distress.
Risk management meant buying insurance against fire, theft, and liability losses sometime back. Now finance managers have more alternatives.
In an article in CFO, Scott Lange, who was head of Microsoft Risk at the time the article appeared, identified these 12 major sources of risk:
1. Business partners (interdependency, confidentiality, cultural conflict, contractual risks).
2. Competition (market share, price wars, industrial espionage, antitrust allegations).
3. Customers (product liability, credit risk, poor market timing, inadequate customer support).
4. Distribution systems (transportation, service availability, cost, dependence on distributors).
5. Financial (foreign exchange, portfolio, cash, interest rate, stock market).
6. Operations (facilities, contractual risks, natural hazards, internal processes and control).
7. People (employees, independent contractors, training, staffing inadequacy).
8. Political (civil unrest, war, terrorism, enforcement of intellectual property rights, change in leadership,
revised economic policies).
9. Regulatory and legislative (antitrust, export licensing, jurisdiction, reporting and compliance, environmental).
10. Reputations (corporate image, brands, reputations of key employees).
11. Strategic (mergers and acquisitions, joint ventures and alliances, resource allocation and planning, organizational agility).
12. Technological (complexity, obsolescence, workforce skill sets).
Lange defined the role of finance in risk management: The role of finance is to put on paper all of
the risks that can be identified and to try to quantify them. When possible, use a number—one number perhaps or a probability distribution. For example, what is the probability of losing $1 million on a product? $10 million?
MBA Core Management Knowledge - One Year Revision Schedule