“Risk and cost in business are like air in a balloon…
each time we press one down , the other one goes up”.
Many times it seems that businesses act like balloons full of air with cost and risk labels placed on their surfaces (Labor Cost; Energy Cost; Price Risk; EPL Risk; and others); and each time management tries to reduce some cost or risk, by pressing on a label, another set of costs and risks labels go up. One example is the activity of outsourcing, which is usually used by businesses to reduce their cost and risk at the same time.
The heart of INSIGHT’s risk management information system is a real-time budgeting application from where the company’s goals and objectives will be measured. This provides a point of reference to be able to quantify risk management performance based on a company’s cost behavior. In other words, instead of treating risk as an isolated cost item that must be measured (Cost of Risk), we will see what risk does to each cost item, and then decide how to benefit from mitigating that risk.
Every year, before starting operations, companies make some assumptions about their expenses (purchase of resources) and revenues (sale of products and services). They will also make some assumptions about how much they will spend on the activities required to turn those resources into products and services. This process is known as “budgeting”. The end result is a number called “net profit”, which should be equal to zero, for non-profit organizations, and greater than zero, for everyone else. If done properly, this net profit should have two components: the actual net profit (as today when t=0), plus the volatility (%) factor as a result of risk.
Profit = P t=0 + %V
This is how risk becomes the difference between actual and expected returns. Risk brings uncertainty and is the source of net profit’s volatility, which translates into “stock price volatility”.
A risk manager’s main goal should be to help the company reduce this volatility to an acceptable level where future returns can be more predictable.