TOLERANCE OF RISK: TOLERANCE OF RISK Slide 2: Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome). The notion implies that a choice having an influence on the outcome exists (or existed). Potential losses themselves may also be called "risks". Almost any human endeavour carries some risk, but some are much more risky then others. Slide 3: There are different definitions of risk for each of several applications. The widely inconsistent and ambiguous use of the word is one of several current criticisms of the methods to manage risk. In one definition, "risks" are simply future issues that can be avoided or mitigated, rather than present problems that must be immediately addressed. The risk is then assessed as a function of three variables: : The risk is then assessed as a function of three variables: The probability that there is a threat The probability that there are any vulnerabilities The potential impact to the business. What Does Risk Tolerance Mean? : What Does Risk Tolerance Mean? The degree of uncertainty that an investor can handle in regard to a negative change in the value of his or her portfolio. Slide 6: Risk tolerance in personal finance is of course the degree of willingness to accept risk of loss in an investment portfolio (in anticipation of correspondingly higher degrees of return). An individual will fill out one of those questionnaires to acquire a rating, such as low, medium or high, and then select investments, perhaps on the basis of the measure of historical volatility (beta risk). In corporate finance, the firm might publicize a statement indicating a general stance or attitude regarding the degree of risk it will usually take on. A “required rate of return”, set by policy, is a risk-adjusted percentage return on capital, used as a guideline to evaluate project proposals. It therefore indicates a degree of risk tolerance. Slide 7: Over the past few years in a volatile market, consumer’s wavering confidence and tight credit conditions many small business owners are rethinking their tolerance for risk. In more favorable conditions, you find a high tolerance for risk in investment strategies versus the current conditions which create fear and panic resulting in a lower tolerance. Unfortunately, many small business owners react to their rears and are making bad decisions in these slow economic times. The goal is to weather the storm by being strategic and creating a plan that diversifies your risk but still allows you to invest in your business Slide 8: Take your emotional temperature. There are a number of factors that can go into your decision and emotion is one of them. Each of us has a multitude of risk tolerances that vary with specific events in our life. In bad times, we have a tendency to try to limit our losses and our rational brains go into overdrive you begin to see decisions to pull back on marketing or perhaps not to invest in that technology this year. This could be very damaging to you. Be sure to take your emotional temperature and use more facts than fiction to make r decisions in your business. Create an investment criterion to evaluate potential investment opportunities and leave the emotion at the door. Slide 9: Think like a maverick. Warren Buffet once said “Amid adversity, there is opportunity”. Find ways to stand apart from the pact and use risk to propel your business. For example, when others are pulling back on investing in their marketing, you should be looking for ways to do more marketing. When others are letting go staff and putting a strain on delivering a quality product, invest in a team that will deliver exceptional service. Although investing in a declining market can be difficult, it has been proven to add more benefit to support long term objectives. Slide 10: Invest for long term over short term . Markets have been changing for hundreds of years. It is how we respond to those changes that impact our business. In declining markets, focus your investment strategies on items that will yield long term results and meet help you meet your overall objectives. In the face of adversity, we have a tendency to want to fix things right now and look for ways to achieve short term wins. Be strategic and invest in opportunities that will yield you longer term benefits: Technology, marketing, sales positioning etc… As business owners we all know how unstable market conditions can transform a calm, cool and collected business owner into an emotional and scattered one. By having a plan and criterion that you can refer to and plan to might be the difference between reaching your long term goals . Slide 11: If the entrepreneur wants their business to grow, they need - 2 traits that must be quickly acquired : Thick Skin Risk Tolerance Thick Skin: Thick Skin People are sensitive to rejection and human beings do their best to avoid rejection at all costs . Conversely , the entrepreneur must become completely desensitized to rejection as they must quickly come to terms with the fact that they are going to encounter resistance and judgment from others every step of the way. Risk Tolerance: Risk Tolerance Many entrepreneurs are taught to focus on controlling numbers and because of this focus, they don't learn how to tolerate mass amounts of risk . Managing a high amount of risk is not easy nor is it fun, but it is necessary. Entrepreneurs, until the business is completely done with its growth phase and can no longer grow at a fast pace, are going to have to live with a gut feeling that is indescribable. Slide 14: These company growth stages that tend to induce a large amount of stress include the transition to an office, the hiring of multiple highly paid employees who are crucial to the success of the business and also training these individuals as the entrepreneur must learn that they cannot control everything. The ability to step back and "let go" cannot be taught anywhere. It is a feeling that can make the entrepreneur dizzy. Example: Example Imagine an IT firm that is doing well and sees potential in branching out into a new area of cyber security. Managers do not have clear agreement on the criteria for success, and guidelines for making incremental choices, as they build the new operation. The firm’s tolerance for risk (or risk appetite) for this specific venture needs definition beyond a simple percentage. Slide 16: Example shows that Enterprise Risk Management cannot rely solely on the notion of risk tolerance as a discrete number, a percentage of capital at risk. Slide 17: Risk capacity: the amount and type of risk an enterprenuer is able to support in pursuit of its business objectives. Risk appetite: the amount and type of risk an enterprenuer is willing to accept in pursuit of its business objectives. Risk tolerance: the specificmaximum risk that an enterprenuer is willing to take regarding each relevant risk. Risk target: the optimal level of risk that an enterprenuer wants to take in pursuit of a speci_ c business goal. Risk limit: thresholds to monitor that actual risk exposure does not deviate too much from the risk target and stays within an enterprenuer’s risk tolerance/risk appetite. Exceeding risk limits will typically act as a trigger for management action. What propels enterpreneurs towards self –employment? : What propels enterpreneurs towards self –employment? There are four factors – Negative displacement, Being between things, Positive push, Positive pull Negative displacement : Negative displacement Negative displacement is the alienation of individuals or groups of individuals from the core of society. These individuals may be seen as not fitting in to the main flow of social or economic life. EXAMPLE – immigrant status,fired from job,angered or bored by current employment Being between things : Being between things People who are between things are also more likely to seek enterpreneurial outlets than those in the middle things. Example – Between army life & civilian life, Student life & career. Positive pull : Positive pull Positive influences also lead to the decision to investigate enterpreneurship & these are called positive pull influences. They can come from potential partner , a mentor, a parent , an investor , or a customer. The potential partner encourages the individuals with the offer of sharing the experience,helping with the work ,& spreading the risk. The mentor raises self –esteem & confidence. Mentors & partners can also introduce the enterpreneur to people inside the social &economic network for new venture activity. Positive push: Positive push Positive push factors include career path that offers enterpreneurial opportunities or an education that gives the individuals the appropriate knowledge & opportunity. There care two types of career paths – Industry path Sentry path Industry path : Industry path A person prepares himself for a job or career in a particular industry & learns everything there is no know about that industry. Because all industries displays some sort of dynamics or change ,over time ,entrepreneurial opportunities that exploit that change come & go. Sentry path : Sentry path The sentry path emphasizes the money & the deal. People in this case see many different opportunities in many different industries. They tend to be lawyers, accontant,consultant &broker. These people learn hoe to make deals & find money. They have contacts that enables them to raise money quickly when right opportunity comes along.