Risk assessment is a major part of any investment decision, as an analysis of the possible creation of shareholder wealth or value must be ascertained before subjecting to any contractual agreement. There are a few known methods of analyzing risk which are - Sensitivity Analysis, Scenario Analysis and Probability Analysis. Theses techniques are used by multi nationals and SME's in assessing risk in relation to investment.
Published in the past week by Paul J Davies on FT.com is a write up analyzing the situation on financial management in various industry and the effect the credit crunch had on the financial risk management of firms. Financial risk management is like the maintenance of financial risk assessment, meaning - the management of financial risk ascertains the assessment carried out at the teething period of investment. The write up explains - “Lots of financial business had what they thought was an effective risk management framework in place, but the crisis showed that it did not do what it said on the tin,” says Clive Martin.
This explains why a lot of firms have fallen short of their investments as, although the investment was right and the risk assessment was well done, bad management of risk most likely creates unplanned scenarios which especially affects the capital payback period as a shorter payback will always reduce the risk arising from the uncertainty of cash flows. Therefore, problems with management can make the payback period even longer which in turn reduces the profitability of the investment.
In conclusion, currently available investment appraisal methods have disadvantages but are still credible and of good use to managers that are able to determine the best method of calculating investment opportunities. Risk assessment also has disadvantages such as time period e.t.c. but the most important aspect of risk is the management. A bad risk assessment can still be corrected with good risk management.
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