Approaches a Non-Financial Company Uses to Address New Projects

Approaches a Non-Financial Company Uses to Address New Projects



Introduction

There are several trends that have emerged in the financial market over the recent past due to the impact of globalization, advancement in technology, deregulation, innovation and disintermediation. The non-financial firms on the other had have also developed with the same competitiveness though their risk assessment and management is slightly different. This paper will address the insights into the monetary approaches non-financial companies employ inasmuch as the approaches relate to the risk management and the financial structure of the company. Basically the paper will also address the way the approaches to defining, measuring and efficiently managing the risks inherent in a Prospective new project evaluation. There are essential principle issues and faced by the non-financial institution particularly in the context of the owners of the company (shareholders). The function of finance in the operation of a non-financial company is still critical. There are non-financial risks as well which will be addressed in the paper though it's pertinent to note that finance may not the elemental part of everybody's responsibility but it is increasingly difficult to survive, let alone struggle without an understanding of the core concepts.



Why Management of Inherent Risk is Crucial

Risk is very important to businesses since it adds value, though this will depend on the individual managing the firm and the nature of the company itself and its tax profile (Carlton 2008), cost of financial endurance, opportunities for investment and the design of the business ownership. Thus the optimum strategies for this achievement are company-specific (Crouhy et al 2006).



Being able to accept that risk is critical. This inevitably translates to the conclusion that that risk should therefore be managed on the basis of the entire company. Financial companies assess the risk and the capital needs that are intimately connected. Non-financial firms however the connection is very little. Conventionally the risk in such firms is usually management on segment basis but in concert with the objective of the business and the functional responsibility of the company like establishing a new project in this instance (Carlton 2008). Coming up with strategies that recognize the total risk that the company faces requires intensive and broad perspective assessment of the possible risk that integrates the comprehension of the dynamics of every business. For a new project, concentrating on the short - term strategies does not increase or enhance the cash flow in a considerable manner; the best tactic is therefore the focus on the risk assessment in the long term perspective(Crouhy et al 2006).



In order to be able to achieve success in the risk definition and identification, then the firm should be able tom establish the following:

Put more prominence on the process of risk management, particularly identification, comprehending and measuring of the exposures (Crouhy et al 2006). Considering that fact that solutions to the many of the problems currently are obtained by derivative techniques, the focus should therefore be on making sure that the correct issues are resolved. This assessment should not only include the new project but also the entire business in terms of the financial risks and managing these risks at the level of the company as a whole (Carlton 2008).



The company's management should be able to focus the greater energy of working on the measurement. The concentration on the risk management performance is a comparatively new and developed from several developments which comprise better external reporting responsibility, some expensive business derivatives losses and wider range of derived products. Regardless of the type of performance assessment method employed, its imperative to align the desired outcomes of the process and the related benchmarks and motivation scheme with the creation of shareholder value (Carlton 2008).



It's also important to make sure that the company is adopting a down to business and satisfactorily aggressive strategy to management of capital. A better understanding of the possible connections between the structure strategies, risk management tactics and management enticement schemes is pertinent (Carlton 2008). There need to be use of the risk managements that are relevant for the non-specific firm. Whereas the value -at -risk procedures are turning out to be more and more popular, such methods are only relevant for non-financial companies under restricted situations (El-Masry 2006). An approach to assessment of risks with concentrates on the assessment of the cash-flow-at-risk' or 'cash-flow-shortfall', rather than the inconsistency in the market value is possibly more suitable (Crouhy et al 2006).



Why Non-Financial Companies Need Different Strategies

The differences in the way risk assessment and management is approached in non-financial versus the financial companies is very critical (El-Masry 2006). The differences that are important to bear in mind when carrying out the assessment include; regulatory - the financial firms only do this in order to safeguard the systems of payment and the systemic risk while non-financial concentrates on corporate governance; nature of assents in financial firms are tradable, highly diversified, financial assets, contractual cash flows while diversification increases quality of the product portfolio (Carlton 2008). The non-financial assets are risk concentration, illiquid assets on balance sheet, non-contractual cash flow and diversification has minimal impact on value: Risk - the function of risk in financial firms is key focus and strategy of the management, it also helps in incorporation of company-wide risks while non-financial risk emerge from physical aspect of the business with little focus on skill. It employs fragmented approach. Risk measurement is the ability to measure risk statistically in financial firms while in the non-financial firms; this is limited capability of measuring most of the risk as a consequence of inadequate observation, and casual relationships (Crouhy et al 2006).



Managing the Risk

There are several changes in the recent past that that have impacted on the management of risks in non-financial companies. the major ones include; changed regulatory environment - among other advances, the changes in the way non-financial firms are regulated has enabled application of share buy-backs and permitted greater way in for offshore markets; globalization - this has enable most firms to reach international market (Crouhy et al 2006). Though this is beneficial, it's often adversely affected by the changes in the global market situations and also progressively more prone to competitors pressure; innovation - this facilitates transfer of risk and also even more tailored capital structures(Carlton 2008); disintermediation - this has totally transformed the function of conventional commercial banks, offering firms with direct access to end-investors. Additionally the function of corporate lending has also changed. Technology advancement facilitates more efficient means of payment and money transfers. On the other hand advanced technology on computer offers a way of carrying out accurate analyses and pricing of derivative transactions (Crouhy et al 2006).



The combined impact of the above-mentioned factors on the financial markets has been an increase in the availability of competitively prices products. Mangers are able to get solutions to a two fold problem. Application and implementation of the current best practices is paramount though these practices vary widely (Carlton 2008). For instance, the stress-testing and value at risk (VaR) approaches have for along time been the preferred tools for assessment during the process of risk management. These core methods are widely used and have been very successful. However poor model design and wrong choices can and have of caused serious, unexpected and possibly preventable losses. For firms whose assets are basically intangible, establishing that value and the associated risks of the assets is a very big problem. Managers also face a challenge of keeping abreast of the excellent practices as they emerge (Crouhy et al 2006).

Cash at Risk (CaR): each derivative and security is made up of cash flows that are anticipated to emerge in future. In this regard CaR financial tools employed on a corresponding foothold with the contractual and expected cash flows of the firm. CaR pushes that corporate treasury further than transaction and bookkeeping experience management to financial experience management (Jorion 2001). The theoretical foundation of the CaR is the arbitrage-free yield curve and FX connection in every currency in which the corporation has experience. Significantly, variable market prices have a great impact on the business elemental elasticities like currency prices on the process of sourcing and pricing (El-Masry 2006). Generalization is very hard to make as the elasticities are firm specific. Hence every model should deal with elasticities and the time of these elasticities since the cash flows in the future are not resolved exactingly by the evolution of rates and pieces in the market (Crouhy et al 2006).



Stress - Testing: in order to compliment the CaR test, the non-financial firm should emphasize cash flow and carry out a stress-test on the impact this would have on the balance sheet in the event of severe market circumstances. The stress -test is a theoretical market rates and pricing circumstances to mirror probable close to terms changes in these prices and rates; For instance, re-pricing a firm's value (Jorion 2001). Correlations between market pricing are not practically dealt with and this presents a Major setback with stress-testing technique as they are with CaR (El-Masry 2006).



Free Cash Flow at Risk (FCFaR): even though the new SEC prerequisite can be fulfilled with stress test and the CaR techniques above, to considerably increase the shareholder value especially when venturing to new project through risk-adjusted capital allotment between the firm need a powerful approach that can account for market and other risks like legal requirements, credit, operational cost and company reputation (Jorion 2001). Free Cash flow (FCF) is a very effective tool that is available to managers, lenders and hence integrates the impact of all the possible risks the firm faces in its performances. FCF is the pay before interests and taxation as well as depreciation minus the NWC (net working capital) changes minus investment (capital expenditures) plus the Tax advantage. (FCFaR) is hence an arithmetic approximation given an exacting probability of how much FCF a certain division risks loosing in a definite period of time because of the changes in the cash-flows (Jorion 2001). The duration of holding is in most cases one quarter of the year since corporate performers are performed on same duration and FCF estimates are habitually made quarterly or yearly.



Shareholder Value Ratio (SVR): this is just like the Risk-Adjusted Performance model that is employed by the financial firms. Shareholders Value Ratio permits the non-financial organizations to allot capital between sections on a risk-adjusted foundation (El-Masry 2006). Normal shareholders value analysis focuses risk only in the alternative of risk-adjusted discount rate for anticipated cash-flows and distributes capital to projects with positive value. The SVR methodology distinguishes that like discounted cash flow (DCF) Analysis only focuses on the expected return side of the setback and does not take into account the explicit correlations between functions (Jorion 2001).

Conclusion

It's imperative that the non-financial companies develop risk management strategies and implement them efficiently in order to be able to manage capital well especially when starting out a new project. The demands of the shareholder have to be met. When developing approaches to define, measure and manage risks for especially for a new project being developed by a non-financial company, it's pertinent for the company to strictly stick to a methodological process to decide the appropriate types of risk measures, policies, controls, and procedures for their specific organization.















References

Carlton T (2008). Risk And Capital In The Non-Financial Firms.

Crouhy M, Galai D & Mark R. (2006). The Essentials Of Risk Management. McGraw-Hill Professional Publishers

El-Masry, A. (2006). UK Non-Financial Companies. Best Risk Management Approaches. Management Finance. 32: 2, pp 136 -158.

Jorion P. (2001). Value At Risk- The New Target For Management of Financial Risk. McGraw-Hill Professional Publishers