INSTRUCTOR MANUAL
Instructor’s Manual for Principles of Finance
03/21/22 1
, Instructor’s Manual for Principles of Finance
Chapter 20
Risk Management and the Financial Manager
Chapter Summary
While conducting its ongoing business, a company will inevitably confront risk. Some risk the
company takes on, and other risks it simply encounters. The most important risks are those that
involve the company’s inflow and outflow of cash. As described in The Importance of Trade
Credit and Working Capital in Planning, “cash is king,” meaning that what impacts cash flow
impacts the value of the company. Conditions that impact cash flow must therefore be
considered risks. To guard against these risks, a wide range of financial instruments and
strategies are available. Some of the major risks faced by a business are addressed in this
chapter.
Lecture Outline
20.1 The Importance of Risk Management
What is risk? A company’s risk manager or risk management department is charged with
identifying risks and managing them. Full risk avoidance is impossible in most business
situations, but risk management can anticipate and mitigate them to the degree possible. The
purpose of risk management is centered on three objectives listed in the text:
increase incoming cash and decrease outgoing cash
speed up cash inflows and delay cash outflow
decrease the riskiness (read: volatility) of both inflows and outflows
The first objective utilizes the income statement to see what the gross cash flow coming into
the company is, primarily from sales. (The company may have other minor sources of revenue.)
Increasing revenue is the engine driving the company business. As seen in the previous chapter,
the second item, assets and liabilities, also generate (+) or use (-) corporate cash flows.
Company risk can be lowered through effective working capital management.
This chapter focuses on the third objective. Restated, it looks at the chances that expected cash
flows will not be realized or will be something less than expected. This is at the heart of risk as
faced by a company. More than just uncertainty, which is a vague concept, risk is the state
where possible outcomes are known and probabilities are assignable. Uncertainty lacks one or
the other of these two conditions.
Risk to a business results from the connection among a) cash inflow/outflows, b) risk of realizing
those cash flows, and c) firm value. Simply put, not realizing expected cash flows can and
usually does affect firm value. There are many approaches to managing this. First, one looks at
positions. In the course of its business operations, a company will take on either long or short
positions. A long position is when the company possesses an asset or will receive it. A short
position is when the company lacks the asset or will dispose of it. (An accounting mnemonic is:
A long position is like cash or accounts receivable. A short position is like an account payable.)
Whether long or short, a position represents risk, and companies normally seek to minimize
risk. Taking steps to manage a risk position is known as hedging. To hedge, a company basically
03/21/22 2
Instructor’s Manual for Principles of Finance
03/21/22 1
, Instructor’s Manual for Principles of Finance
Chapter 20
Risk Management and the Financial Manager
Chapter Summary
While conducting its ongoing business, a company will inevitably confront risk. Some risk the
company takes on, and other risks it simply encounters. The most important risks are those that
involve the company’s inflow and outflow of cash. As described in The Importance of Trade
Credit and Working Capital in Planning, “cash is king,” meaning that what impacts cash flow
impacts the value of the company. Conditions that impact cash flow must therefore be
considered risks. To guard against these risks, a wide range of financial instruments and
strategies are available. Some of the major risks faced by a business are addressed in this
chapter.
Lecture Outline
20.1 The Importance of Risk Management
What is risk? A company’s risk manager or risk management department is charged with
identifying risks and managing them. Full risk avoidance is impossible in most business
situations, but risk management can anticipate and mitigate them to the degree possible. The
purpose of risk management is centered on three objectives listed in the text:
increase incoming cash and decrease outgoing cash
speed up cash inflows and delay cash outflow
decrease the riskiness (read: volatility) of both inflows and outflows
The first objective utilizes the income statement to see what the gross cash flow coming into
the company is, primarily from sales. (The company may have other minor sources of revenue.)
Increasing revenue is the engine driving the company business. As seen in the previous chapter,
the second item, assets and liabilities, also generate (+) or use (-) corporate cash flows.
Company risk can be lowered through effective working capital management.
This chapter focuses on the third objective. Restated, it looks at the chances that expected cash
flows will not be realized or will be something less than expected. This is at the heart of risk as
faced by a company. More than just uncertainty, which is a vague concept, risk is the state
where possible outcomes are known and probabilities are assignable. Uncertainty lacks one or
the other of these two conditions.
Risk to a business results from the connection among a) cash inflow/outflows, b) risk of realizing
those cash flows, and c) firm value. Simply put, not realizing expected cash flows can and
usually does affect firm value. There are many approaches to managing this. First, one looks at
positions. In the course of its business operations, a company will take on either long or short
positions. A long position is when the company possesses an asset or will receive it. A short
position is when the company lacks the asset or will dispose of it. (An accounting mnemonic is:
A long position is like cash or accounts receivable. A short position is like an account payable.)
Whether long or short, a position represents risk, and companies normally seek to minimize
risk. Taking steps to manage a risk position is known as hedging. To hedge, a company basically
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