Risk Analysis & Decision Making

In earlier write-ups we have seen, understood the terms Management Accounting, evolution and it’s need. The term Management Accounting has gone a long way and has been constantly getting reinvented in how best it can be used. The economic crisis which has swept the world economy has resulted in increasing the significance of Management Accountant and thus developed the new phenomena of Management Accounting by Risk.

We will tie this to the popular financial management concept of Risk Analysis. In financial terms, the term risk is classified into –

  • Systematic Risk (Environmental Risk and common to everyone)
  • Un Systematic Risk (Specific Risk and can be mitigated with proper planning)

Systematic Risk:

Systematic Risk can be described as any risk that can’t be diversified or which is pretty much common and unpredictable in nature and affecting the economy as a whole. Such as recession, global slowdown etc.,

Unsystematic Risk:

Unsystematic Risk can be described as any risk that can be reduced by methodical diversification strategies / techniques. These are unique to the Company or the Industry in which a company operates etc., viz., for Cement Industry availability of Lime stone (raw material), for Milk Industry availability & proper connectivity of organized logistics / distribution network

Total risk is the combination of the Systematic & Unsystematic Risk. As a Management Accountant, one is expected to weigh the decisions incorporating the risk into the decision factors. This can be measured using a mathematical co-efficient called ‘Beta’.

Beta can be measured by considering the volatility of an entity’s position against the movement in the economy as a whole. This could be graphically represented with the help of regression analysis.

risk_analysis

If an entity’s beta is greater than 1, it is expected to have systematic risk proportionately greater than the risk of the Economy. Conversely if an entity’s beta is less than 1, it is expected to have systematic risk proportionately less than the risk of the economy. However, to use beta it is necessary to assume that beta calculated on the basis of historic information / experiences is a reliable indicator of current and future risks.

Comments

  1. Muslim Rashid Abbas says:

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    Mr. Muslim Rashid Abbas

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