Academic Open Internet Journal

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Volume 11, 2004

 
 
RISK MANAGEMENT IN A BULGARIAN COMPANY

 

Snezhanka Ovcharova , Headassistant Prof. PhD. eng.

Varna Free University

Programme “Business Administration and

International Economic Relations’

 

 

 

Abstract:  The present paper examines the application of risk management in the conditions of a Bulgarian company. Analysis of risk in company’s activities is carried out as well as a risk management program is elaborated, which is an intrinsic part of the strategic company management and ensures its sustainable functioning and development within market economy. 

 

Key words:  risk management, strategic management, business risk.

 

INTRODUCTION

Each company functions within the market economy as an element of the surrounding environment and it is in constant interaction with the latter. Every entity from the company’s surroundings has its own interests that are hard to be foreseen. This uncertainty of the economic environment hampers management decision-making. However, the need to survive as well as the entrepreneurial searches requires taking a risk. Yet, risking in the dark without considering the possible outcome is quite shortsighted. Any risk should be estimated in advance, calculated and conformed to the available potentials.  The issues related to risk management and risk capital assumes major importance in market economy. They are particularly relevant for the functioning of Bulgarian companies.

Therefore, all this gives rise to the question of risk management as well as that of risk capital management and its adapting to the practice in our country. At the current stage, the majority of the company managers in our country comply with signing insurance contracts as well as with some preventive activities. There is no overall concept for research of the risk, of the ways for its neutralization; of the price for achieving the desired level of security. Functioning within the market economy requires greater attention paid on this problem. It is necessary that each enterprise, and the government respectively, elaborate concepts for management of risk and risk capital. That is a complex task and it is very important to employ the contemporary methods for risk management. Thus, any considerable losses will be avoided, that otherwise will lead to impediment of the renovation of our economy.

The present paper examines the application of risk management in the conditions of a Bulgarian company – “KL” AD. A program for risk management is elaborated being intrinsic part of the strategic company management and ensuring its sustainable functioning and development within market economy. 

 

 

     1. Presentation of the company  

The company “ÊL” AD is average in size (it comprises personnel of 120 people) and it is the only one in the country producing systems for air-conditioners in enterprises, public buildings, etc. It was established in 1990 and is registered as public limited company with 70% private capital and 30% state-owned share. The company has bought the premises and the technical equipment of the existing until 1972 state-owned factory for dedusting devices, which was forced into economic insolvency. “KL”- AD has adopted the assets and liabilities of the factory. It has preserved its main activity and has simultaneously introduced two new assembly lines – for the production of dust collectors and heat exchangers, which turned out to be enjoying a very high demand on our market. It has also preserved the jobs of the highly qualified staff. Apart from production, in the recent 2 – 3 years the company has been offering also assembling and repairing of the articles and the air-conditioners on the spot.

In order to enhance the efficiency of its management, “ÊL” – AD has divided its activities into separate units (profit centers). Each unit has its own operative independence – it plans its activities, elaborates strategies, which comply with the global strategy of “ÊL” – AD [1].

The principles for company’s global strategy development are the following:  

1)     Improving the image of the company through appropriate advertising and entering the international market

2)     High quality of production

3)     Price of production

 

The long-run main goal of the company is extending the size of the production of the high-quality articles. 

 

2 Elaborating a risk management program in the company “ÊL” - AD

The application of contemporary risk management in the business strategy of the company “KL” – AD allows for the solution of a number of problems. The main goal is oriented towards attaining security, which will ensure continuous production process, maximizing profit, preserving market positions and surviving of the company with optimal level of costs.

The company applies three stages for exerting influence on the risk situation and the company’s risk:   

1.      Analysis of the risk situation;

2.      Control over risk;

3.      Monitoring and Risk Management Program (RMP)

The analysis of the risk situation as a first stage is aimed at rendering qualitative characteristics and quantitative assessment of the risk exposure of company “KL” AD. This includes two main procedures: diagnostics and risk measurement.

The second stage – Control over risk is related to taking specific management decisions concerning the impact of risk and their practical implementation. The form of control depends on the type of risk (the risk profile) estimated during the analysis. The defining criterion is the size of the risk represented by the probability of its occurrence and the amount of the possible losses. Orienting factor can be the price of the impact, i.e. the costs and the economic benefit of company “KL” AD from adopting one from of control or another.     

The third stage is monitoring and information provision of the Risk Management Program (RMP).

The process of elaborating such a program comprises two phases: preliminary and essential. The preliminary phase of RMP involves manager’s examination of the referential and current specific information related to “KL” AD, which will help him/her in making major decisions in respect to the risks threatening the company and go on to the Essential phase – elaboration of RMP at “KL” AD. Its implementation and realization will help reducing the possibilities for company losses.

The major stages in elaborating RMP are demonstrated in table 1:

 

                                                Table. 1 Main stages in elaborating RMP

¹
Íeadings of the stages in elaborating RMP

1.

Specifying the company strategy in risk management and choosing the procedures for its realization

2.

Preliminary selection of risk

3.

Analyzing of risk

4.

Choosing preventive activities

5.

Control of RMP

6.

Evaluation of RMP’s efficiency

 

Each of these stages will be examined in detail further in this exposition.

 

2.1 Specifying the company’s strategy in risk management and choosing procedures for its realization

A major pinciple that should guide managers in elaborating and implementing RMP is the compliance with the global strategy of the company.  The company’s strategy concerning the risks could be of various types: cautious, risky, balanced.

Qualitative criteria for the choice of risk management procedures are the threshold values estimated either against the probability for loss occurrence or against their amount in certain sectors and aspects of the company’s activities. The marginal values against loss probability or amount can be estimated separately for the immovable property, equipment, company’s liability before the employees and the society, etc.

Considering the company’s activities and in accordance with the aforementioned goals we can define the strategy of “KL” AD for risk management as a balanced one. The following procedures are equally applied with it: abstaining from risks, taking risks, relaying the risks to another entity. 

 

 2.2 Preliminary selection of risk

At the second stage of the program it has to be specified, which risks the study will be concentrating on.  The RMP of company “KL” AD takes into account the straight economic risks related to business expenses as well as the economic risks related to financial operations.

Regarding the speculative economic risks and their related financial operations, they can become object of a specifically designed financial risk management program.

At the next stage, the economic, financial and currency risks in “KL” AD are analyzed and measured.  

 

2.3 Analyzing the risks in company “ÊL” AD

1) Analysis of the business risk

A major component of business risk is the market risk, which can be defined as a probability for reducing the size of sales. These changes have substantial impact on the amount of the revenues and the financial result, and respectively on profitability too. Information on the possible changes in the sales size can be obtained through a statistical method for analysis, comprising of calculating the so-called “main activity revenue variation coefficient”. That is the standard deviation of revenue as a relative value represented in percentage. The greater the variation in revenue is, the larger the uncertainty concerning sales will be. While calculating, it is advisable to choose a period of at least three years. [2].

 

The following worktable 2 is used:

                                                                                                            Table .2

Year

Revenues from sales

Annual  % inflat.

Compar. Revn.  Qi

Qi – Q

(Qi – Q)2

1

613

1

606,87

22,08

487,5264

2

703

6,2

655,41

70,62

4987,1844

3

588

11,4

492,10

-92,69

8591,4361

Amount

-

-

1754,38

-

14066,1469

 

where Q is the average amount of revenue from the period:

                   ,                                     (1)

The average standard deviation of the revenues σ for the period is:

    ,                    (2)

Then Vσ is the coefficient of the revenue variation for the period:

                       ,                                  (3)

The variation coefficient is in the amount of Vσ = 11.7%. This shows good stability, regularity of revenues and low risk level.

In terms of risk measuring Vσ can be also applied with the company financial result:

                    ,                                                   (4)

where Q is average size of profit from the period.

The average standard deviation from the profit σ for the period.

                                ,                                                (5)

Vσ is the variation coefficient of the profit for the period:

                ,                                   (6)

The coefficient is in the size of Vσ = 25.42%. This is a comparatively low level of variation indicating a relatively good stability and regularity of the financial result.

The business risk of the examined enterprise is considerably influenced by the following factors, which should be taken into account by the management team:

1) The company sales are largely dependent on the general economic and social condition of the country, where, currently, one can note decrease in consumer demand, which should signal a greater attention. 

2) With the increase of competition, risk also increases, which requires technological renovation.

3) There is a need for flexibility in respect to pricing and for searching for new markets. The enterprise is strongly dependent on external supplies as well as on   demand, which requires concluding long-term contracts, if possible, with suppliers and clients.

 

2)  Analysis of the financial risk

The present paper defines the financial credit rating of “KL” AD by a specific date on the basis of the Balance Sheet and the Profit and Loss Account of the company. Generally, this methodology is used by banks when checking and evaluating the credit rating of a company – applicant for crediting, yet it could be used also by the management of any enterprise for preliminary evaluation of its own actual chances for receiving the demanded loan [3]. 

The overall credit rating of the company by 31.12.2002 is defined as Âàà (overall evaluation grade 2) “Indication for instability of any element of financial stability”.

Financial risk is measured on the basis of four groups of indicators: liquidity, cash flow, indebtedness, loan servicing;

In most general terms, the following ratios can be calculated for the preliminary financial risk analysis of the examined enterprise:  

-         Capital mechanism (CM), which equals the ratio:

                                                     (7)

CÌ indicates if the capital mechanism is strong or not. For this particular case CK<OC, therefore CM is a weak one.                                                                                          -   The ratio of debt against the amount of owned capital and debt. According to data from the analyzed company this ratio is as follows:

                                                 (8)

           The indicator reveals the relative share of the loan capital within the total capital and it shows that the debt represents 31.40 % of the total capital. World practice has shown that it is better if it fluctuates between 30 % and 60 %, as the case is. In this particular case, the increase of debt within the total capital of the enterprise will lead to increase of profitability of the owned capital. In order to realize this attribute of debt, the financial lever, it is necessary to observe the condition: the profitability percentage should be greater than the interest rate of the received loan.

The factual data of the examined enterprise show that it has a comparatively low level in respect to financial risk. The company could be recommended to increase the financial risk, provided regular realization of goods is ensured. 

3)  Currency risk management

An important element of “KL” AD activities is the foreign trade of the company.  The foreign trade transactions are complicated and difficult for realization operations. They are also related to most numerous and various risks both for the buyer and the seller. The risk with foreign trade activities could be defined as a loss, respectively decrease in profits caused by the inability of the negotiator and the decision maker to assess processes and phenomena from the micro and macro environment that are hard to be foreseen.   

The company “KL” AD carries out foreign trade activities with Austria, Germany and Russia. In these activities goods leave the possession of the seller at a certain time and place and enter into the possession of the buyer at another time and another place. The factors “time” and “space” determine the conditions under which every transaction takes place. Their greatest importance is with foreign trade operations. 

The importance of the factor “time” has been recently growing alongside the increase of sales in cash and on credit in international trade. The longest period between concluding the deal and its payment is namely the one with the realization of a company’s foreign trade activities. With those prolonged periods for effecting the transactions “KL” AD comes across risks issuing from the changes in the currency rates on the commodity, cash and capital markets. The company’s managers have also considered the changes that have occurred in the legal regulations of the foreign trade in Russia and more rarely in Austria and Germany.

“KL” AD has been also considering the often changing production conditions both with our party and with the buyers. Each of these changes affects the interests of both parties.   

When referring to the factor “space” it should be pointed out that with the establishing tendency of extending the geographical scope of the international activities and the further distancing in space of the buyer and seller the foreign trade risks increase as well.

By the time “KL” AD production arrives to the warehouses of the foreign clients it travels a long distance, changes several types of transport, goes under administration and control of various legal entities and individuals, goes from one jurisdiction into another. 

All that complicates the international trade of the company “KL” AD as well as increases the possibilities for occurrence of various types of risks with various origin and nature. Their diversity requires the application of various methods and approaches to avoid them.

With their improper recognition as well as with an inadequate reaction of the manager, the company could suffer huge losses, which would hardly be compensated.

Therefore, “KL” AD carries out its foreign trade activities with the heightened attention of its top managers aiming at facing fewer risks and possibly suffering smaller losses.

The following risks valid for the company can be outlined:

 

             -  transport risk, originating from damaging of the goods and their packaging during transportation or loading and unloading;

- commercial risk – from failure to fulfill the contractual obligations on the part of company “X” in case it refuses to accept the goods;

-      risk of nonpayment of the goods already received by the buyer – debtor’s risk;

-      political risk – if there are political processes taking place such as strikes, etc.  leading to changes in the economic situation of the importing country. It is the very political risk that causes the fluctuation of the prices of goods (price risk); currency rates fluctuations (currency risk); and the risks of nonpayment of the goods (debtor’s risk) for the Bulgarian company.

The risk faced by the Bulgarian company could be reduced to a “small one” if certain measures are to be taken for insuring, including currency clauses, a more appropriate form of payment and allocation of responsibility prior to transportation of the goods.    

 

2.4  Choice of preventive activities against risks at company “KL” AD

 

Although it creates a number of risky situations and perils for the companies, the market in the genuine market economy presents also large opportunities for avoiding risks or at least for their reduction.

Important characteristics, which should be taken into account when treating risks is their size and “the price” (i.e., what funds will be necessary) for their counteraction. 

In view of security and the complete elimination of risk, the most efficient method employed by the company, including the examined company – “KL” AD, is risk avoidance. 

By its nature, this method consists of rejecting one initiative or another that contains many uncertainties. Its major disadvantage is that the regular avoidance may form a managerial stereotype of behavior represented in a constant strive to avoid taking risks. “KL” AD has good specialists available, who take into account the aforementioned points when carrying out their activities. However, they also accept that eliminating risk destroys progress and entrepreneurial initiative and may cause omission of profitable and relevant business.

The market present large opportunities to “KL” AD for preventing certain management risks (marketing and stock exchange risks). Thus, with the apparent stagnation on the domestic market leading to poor and inefficient realization of the company’s products, the company transfers and re-positions its products on new segments of the market range expressed in entering the Russian market.

Such marketing, financial  and commercial risks can be avoided only with very high level of awareness and complete orientation of the product towards the market welcoming that type of production.

Prevention is another form of influencing and reducing risks employed by “KL” AD in its activities. The preventive measures are targeted on the risky circumstances both in the internal and external company environment and have the objective to reduce their impact.

Prevention is efficient for the business risk as company “KL” AD is established on a sound legal and financial  basis. That is guaranteed by the indicators characteristic for its image: liquidity, solvency, profitability, credit rating (Baa). They prevent the company from a number of shocks and risky situations.   

Risk restriction – the company applies this preventing method when all the other employed methods have not had sufficient impact. Restriction is aimed at narrowing and, if possible, stopping risk’s dissemination as well as loss accumulation. Similar to prevention this method is realized through conducting organizational, technical, technological and financial activities. Important prerequisite for its efficiency is the timely and relevant manager’s reaction in the particular situation.

Transfer of risk to professional insurers.  The longstanding practice of company “KL” AD has proven that from economic perspective the most appropriate method for fighting risks is insurance. However, the insurer does not take responsibility for all company risks but only for those meeting certain conditions for insurability. The most essential of these conditions is that the risk occurrence should be accidental and not known to the managerial bodies. In future, insurance will have an ever more important role in fighting risks, since apart from compensating losses it employs also other methods for fighting risks such as prevention and restriction, etc.

 

Another method for combating risk is self-insurance. It is realized through establishing specialized cash funds for compensating losses occurred as a result of any risks. Therefore, self-insurance is applicable against all types of risks regardless of the fact whether they are insured or not.  

At “KL” AD self-insurance is viewed as a necessary auxiliary means, when the insurer rejects certain risks as well as in case of proved inefficiency of the insurance cover – e.g., the high price. 

Virtually, this suggests that the means from the self-insurance fund, allocated by the company are directed for complete or partial compensation of the occurred losses and expenses.

 

The dilemma insurance or self-insurance will be largely influenced by the conducted financial and crediting policy in our country. The high interest rates offered by the competing banks are attractive and at least for the time being they stimulate self-insurance realized through depositing of cash funds with the banks, which are to be used with loss occurrence.

As far as the examined methods for risk prevention are concerned they do not exhaust all the possibilities in this field. The greatest variety of prevention methods is with treating the entrepreneurial risks. It varies widely since it is dependent on the market situation and on the manager’s ability to react most adequately, where there are no prescribed formulas or standards to be given.  

 

 

2.5 Control over RMP

The objective of the risk management program realization control as well as its revision is required by the constantly changing risk situations in the company. The initially established RMP is based on the forecasted development of the events in the company – equipment breaks down, there is fire or theft, the company becomes liable to its clients, etc. The amount and the directions for spending the cash funds set in the program and designed for covering losses have a forecast nature. However, upon the factual occurrence of the damage it becomes clear what the actual covering costs are. Therefore, the revision of RMP is required in order to make corrections with consideration to the damages, which the company has already experienced. 

Furthermore, the manager for risk management should regularly make sure that RMP matches the current needs. The conditions are changing in the course of time – laws, technologies, necessity for new assets, new employees are recruited, etc. Each change generates new sources of risk or modifies the already existing ones. Therefore, the manager should be timely informed on the important changes and be able to assess properly their impact and reflect it in RMP.  

 

2.6 Assessment of RMP efficiency

 

The assessment of the efficiency of the elaborated RMP is based on the comparative analysis of the values of the maximum possible and the most probable loss before and after the implementation of RMP. The comparison is carried out on the basis of analysis of the coefficients of change of the maximum possible and the most probable loss under the following formulas:

 

                                                                  (9)

 

 

                                                                    (10)

 

Êc ML  è Êc PL  are coefficients of change of the maximum possible and the most probable loss;

ÌL è ÌLRMP – is the maximum possible loss of the company before and after the implementation of RMP;

VL è VLRMP – is the most probable loss of the company before and after the implementation of RMP.

 The coefficients show the share of reduction in the particular type of loss with the implementation of RMP. The greater that share is, the more efficient the program will be since it ensures savings from losses.

 

The creation and implementation of RMP in compliance with the presented contents, procedures and risk management methods is a complicated process. However, practice around the world has shown that RMP ensures conditions for a successful functioning of the company to the expense of reduced possible losses.

 
Conclusion

The functioning of the companies within global economy suggests the emergence of new risks, which are comparatively lesser known to Bulgarian managers. There is evidence for risk in all areas of business, where in some spheres it is more notable, while in others less apparent. The various types of risks are accumulated in the enterprise and they exert their impact on it simultaneously. The elaboration of a risk management program allows for regular observation and measurement of risk as well as for taking measures for loss reduction.

The integration of risk management in company strategic management enhances the confidence of the managerial bodies and increases the efficiency of the decisions made by ensuring sustainable development within the global environment.

 

 

References:

1. Ovcharova Sn. “Establishing Profit Centres in Industrial Enterprises”, dissertation, 2000.

2. Todorov, L. “Business Risk – Nature, Indicators and Method for Analysis”,  issue 22/1999

3.  “Methodology for measuring the financial credit risk”, “Banks” journal ,  book 1/1998.

 

For contacts: 

Snezhanka Ovcharova,

E-mail:   sn_ovcharova@yahoo.com

h.tel. 052/ 60-88-21,

GSM 0887 418 622

Technical College - Bourgas,

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