Assume you have just been hired as a financial analyst by Tennessee Sunshine Inc. (TS), a mid-sized Tennessee company that specializes in creating exotic sauces from imported fruits and vegetables. The firm’s CEO, Bill Stooksbury, recently returned from an industry corporate executive conference in San Francisco, and one of the sessions he attended was on the pressing need for companies to institute enterprise risk management programs. Because no one at Tennessee Sunshine is familiar with the basics of enterprise risk management, Stooksbury has asked you to prepare a brief report that the firm’s executives could use to gain at least a cursory understanding of the topics.
Enterprise risk management (ERM) refers to the processes and methods implemented by firms to keep risk within the risk appetite of the firms. At the same ERM ensures that simultaneously the organizational objectives are also achieved. The components of the ERM framework explain the process in which an organization deals and implements risk management. The elements of the ERM frameworks as designed by the COSO are as follows:
The first and second component of the ERM framework focus on studying the internal environment and establishing objectives to be achieved. These two components are associated with analysing the firm's internal conditions such as work culture, firm's vision and mission and so on. This is done in order to determine the goals which are to be achieved at all levels of the organization. Thereby, an important part in this process is to determine the magnitude of risk, the firm can handle.
The third component of the ERM framework is the process of recognizing the risky events. The first step to risk management is to identify the risks. Risk events are defined as an unforeseeable event which has the capacity to impact a company's predetermined objectives and it can also cause losses.
The fourth component of the ERM framework is the assessment of the risk. Risk assessment is an important element of the risk management system and it has two stages, which are:
Estimating the probability of the risk event to occur.
Estimating the resulting impact on a company's objectives.
The fifth component of the risk management process is risk response. Risk response is the component which comes after the identification and assessment of risk and it focuses on how to deal with a particular risky event. The various ways in which firms respond to risk are as follows:
Avoid the activity altogether due to which risk will arise.
Prevent the chance of occurrence of an unfavourable event which causes losses for the firm.
Take necessary steps to reduce the magnitude of the loss or damage in case a risky event occurs.
Shift the burden of risk to an insurance company
Firms may choose to outsource the activity due to which risk arises to a third party.
Firms may hedge for risks using derivative instruments.
Another response to risky events is to just accept the risk
The sixth component of the ERM framework is control activities. These activities include the processes and mechanisms which ensure whether or not risk management is being carried out as decided by the management.
The seventh component of the ERM framework is information and communication. This activity deals with the process of giving feedback to the management regarding the implementation of the risk management techniques.
The eight components of the ERM framework is monitoring. This includes the tracking and observation of the risk management techniques applied in the firm. And thereby the management identifies any new risks and addresses them accoridngly.
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