Taking risks has always been an element of any corporate venture. Without risks there would be no gains. A key to successful corporate management is identifying risks that yield the greatest gains and identifying how to hedge and manage those risks. Consider the beginning of the financial crisis in 2008. It took only a few days after Lehman Brothers went belly up and AIG was nationalized for the markets of risky credit to come to a complete halt. Poor risk management allowed these events to spread across the entire banking system.
To properly manage risk, you must first be able to accurately measure it. For corporations with different long-term projects, this requires a measure of risk that incorporates the causes of risk that may or may not be found in accounting statements and that provides data that allows risk managers to assess the extent to which the firm is exposed. For most profit-generating activities of a firm, this means measuring the risk of the cash flows of each project the firm is undertaking. Cash flow at risk (CFaR) is a measure of risk that meets these criteria.
The current environment for high information flow, cheap computing power, and advances in statistical techniques can be combined to measure risk exposure in ways that were unavailable even 10 years ago. Using CFaR to analyze your risk will provide answers to key questions, including:
- What is the most I can lose by investing in this project?
- How do the relationships between inputs and production affect my risk exposure?
- How does my intuition about the impact of changing market conditions affect my measure of risk exposure?
- How much do I need to hedge?
Your ability to measure and hedge risk affects the overall profitability and competitiveness of your firm. Is your organization doing all it can to properly measure and deal with the risks of the long-term projects it is undertaking? The Accenture Academy course Enhancing Business Decisions Using Cash Flow at Risk (CFaR) can help develop your understanding of CFaR in the context of a production-based business.