Sources of Working Capital
Many organizations do not survive for long because of unplanned, untimely and insufficient financing. These organizations commence operation before arranging adequate financial funding and disbursement arrangements for their day to day expenses. In order to avoid time and cost overruns resulting from inadequate fund flows, it is advisable to initially ascertain the available financing sources and their disbursement procedures and methods. This research will study the main sources of Working Capital.
Working capital estimates are necessary for including the firms margin of working capital in the estimation of capital costs itself, assessing the impact of interest costs on the viability and feasibility of the firm, and most importantly making arrangement for finances well in advance, so that when actual production commences no constraints are experienced. Before thinking of sources of finance, one must first determine what is needed, how much money of different currencies is needed for each of the major tasks or work packages envisaged and included in the working capital and when is the requirement as to the daily schedule.
We encounter very specific problems when ascertaining the sources of finance required for working capital discount rates, dealing with runaway inflation, factoring specific risks into the every day working of the business. This thesis could draw up a list of all the specific sources of working capital and how best to acquire it.
Another issue to be tackled could be the cost of working capital for a company facing closure. The point of discussion could revolve round the issue of whether the cost of working capital for an unhealthy company is any different from a healthy company in the same line of business. In the real world the creditors do charge more interest rates so as to factor in the risk of the loan being likely to be written off.
There are some steps to be taken before estimating your requirement of working capital. If you are not going to invest your own finances in working capital, then an in-principle agreement based on preliminary estimates has to be reached with the financial institutions who may give you overdraft facility for working capital and fix a favorable rate of your own margin of the working capital locked in work-in-progress, or in inventories, finished goods, and bills receivables and debtors.
Reasons for short-term rate of interest emerging as the main instrument of monetary policy
Introduction
One of the strengths of a country is its economy. In order to have a strong economy, the institutions through which finance is controlled may develop policies to stabilize the economy. Financial institutions like banks are of importance in this regard. This is because of the fact that they govern the manner in which money is treated the value that money is worth is directly affected by bank policies.
In addition to bank policies and the way that banks control the economy, the people are also of importance because it is through them that the currency is circulated. The investments that go into banks and the loans that people receive are all governed by bank policies, but it is the intentions of the people that keep the economy going. So when policies are made, people react and it is this action and reaction that produced an effect in the economy. The intended effect on the part of the government is to strengthen the economy as much as they can. In the long run, this is what is hoped for through short-term rate of interest a strong and stable economy, and a currency with better value.
Institutional Function
Generally, interactions are known to create effects that can be amplified, and this depends on the nature of the active components, such as those in a major economy. When banks have the liberty write financial policies, other financial institutions are affected, and in turn, people too are presented with choices that might be confusing for them. The reason why policies might be confusing for people is because of the fact that they may not be able to understand why exactly things like interest rates are modified. They are well aware that they may not earn enough interest in this way, and feel that the government is deliberately denying them of maximizing their profits. For those that do understand why this interest rates are changed, they may simply be disinterested and search for alternative means of maximizing their interestprofits.
Financial Policies
Financial policies, like those on short-term investment, indirectly control the economy and can keep inflation in check and also increase the value of currency. Therefore, short-term rate of interest policy is an effective means of controlling the economy. It is effective because of the fact that inflation is an important player in the economy. The government realizes this aspect as well as the fact that the Bank of England is the best tool for developing policies that could effectively deal with inflation. Since one of the Bank of Englands main concerns is monetary stability, it is the best body to make policies that would control the economy.
Worries over Inflation
With a current inflation target of two percent, the Bank is apparently on target with its short-term rate of interest policy. It is hoped that confidence in the currency will be restored this way. The government is still keen on strengthening the economy and restoring confidence in the currency even though they are well aware of the present strength. However, it must be asserted that in order to be a strong and formidable competitor in the market, they need to set targets. Therefore, it can be asserted that the Bank of England and the government have agreements to strengthen the economy through short-term rate of interest.
Reducing Inflation protection in investment schemes
It is believed first of all that short-term rate of interest is a method of avoiding inflation protection that is associated with long-term investment. Even investments such as insurance have inflation protection, but short-term investments can do away with it. In addition to short-term investment saving itself from investor demand for inflation protection, it helps in securing the economy. This is because of the fact that there is much less risk involved with short-term rate of interest. If, through short-term rate of interest, inflation stays low, the government can maintain its hold on price stability. This is understood on the basis of inflation being kept low if inflation remains low, prices will remain stable.
Main Reasons for Short-term Rate of Investment
While keeping prices stable is the governments objective, the Bank of England wants to increase the value of the currency. Hence, together, they both are working towards aims that will benefit the economy and serve each others purpose.
The mechanism adopted is as follows
The government wants to keep inflation low
So, the government allows the Bank to develop policies that would control inflation
By controlling inflation through short-term rate of interest policy, the value of currency is protected.
This has been made a reality because of the fact that the price of money in countries like the UK is controlled through interest rate. An important point to also remember is that low inflation is not an answer to economic problems and increasing the value of a currency. What one can say is that it is vital to encouraging stabilization of the economy in the long run. Short-term rate of interest seems to fit well when one talks about lowering inflation while long-term investments almost encourage inflation. This is to say that if investments are short-term, investors probably will not ask for inflation protection because the need does not arise. Stability will be secured on both sides, for the investor and the bank, because short-term agreements have fewer risks. Consider if a person wants to invest repeatedly, each time an investment is carried out, a new contract falls into place. This means that if there is a change in the state of the economy at any point, it can be applied in the next round investment.
In addition to this, the effects of an increase rates should also not be forgotten, and this is because of the fact that it can slow down an economy tremendously and impede investments. Markets and employment will also be adversely affected by the increase in rates.
Possible effects of Short-term Rate of interest
Observing the reasons why short-term rate of interest has emerged, tells one that there is an all out effort to ameliorate the economy and bring about stability along with increasing the value of currency. However, the downside of the efforts through which this is achieved, are ones to take note off. This is because investments may be slowed down considerably. However, in contrast to this consideration, if stability is achieved in the economy, foreign investment is more than likely. This in itself would help to improve investments, which means that people within the UK who do not invest would simply be missing out on opportunity. They need to realize the number one priority is stability in the economy once that is achieved, they can invest their money and receive returns safely. Foreign investors as well would have security in investments if the economy were stabilized.
One point that is necessary to make here is that in short-term investments, inflation can be addressed with each new term. Therefore, foreign investors stand to gain from investing in the UK they would have a definite idea of whats going on and be more aware of the value of the currency each time.
Coming back to the effects of short-term rate of interest on people in general, one can say that people would be affected by the fact that the curve of revenue available for loans would diminish. This is because of the fact that the banks will not be receiving the same amount of investment as they used to because of the new policy. So, there would obviously be a decline in the amount of revenue available for loans. In addition to this, another important consideration is that since investments are arranged on shorter terms, the period of time for which loans are given will have to be reduced in order to create a balance between revenue coming in and revenue going out.
In the long run, it is possible that the banks may not be able to allow loans in the manner that they have been doing. Those who wish to start small businesses with loans, for example, may not be able to do so, and this could impact the economy. Investors at the same time, might want to wait until the Bank of England changes its policies, and as a result investing can remain slow for a long time. However, it is hopeful that investors realize the long run advantage of short-term rate of investment and put their faith in this policy.
Conclusion
Given that people need to be confident in the economy so that they would want to invest their savings, an economy has to be stable. This refers to foreign investors as well, as they need to feel confident in the economy where they invest. One of the known successful ways to develop a strong economy is through short-term rate of investment. Some of the things that have led to this method of strengthening the economy include the governments need to combat inflation and develop currency value. These are shared interests of banks as well, which are the makers of policies that favor strengthening of the economy. With their policies for short-term rate of investment, they are creating a situation where perhaps the number of investors is lowered, but the value of currency is strengthened in the process. Also, the low inflation rate remains targeted along with the prices remaining in check. Such a scenario desired by the government justifies implementation of short-term rate of interest.
A personal description of an effective and efficient risk management process.
A Description Of An Effective And Efficient Risk Management Process.
Risk and uncertainty are terms basic to any decision making framework. Risk is imperfect knowledge where the probabilities of possible outcomes are known and uncertainty exists when these probabilities are not known. Uncertainty is therefore imperfect knowledge and risk is uncertain consequences. Uncertainty is central to all projects and that uncertainty management is a more descriptive term of the risk management process, and more appropriate for managing the sources of uncertainty that includes risks, threats, and opportunities. Ambiguity is associated with uncertainty in the interpretation of variable data sources influenced by the behavioural constructs of those involved in the process. Clarification and hence management of ambiguity and uncertainty, improves the effectiveness and efficiency of decision making. This management process is mirrored within a project environment.
Uncertainty in a project includes
which parties ought to be involved,
the alignment of motives,
the alignment of project objectives,
shaping the design and resource requirements,
choosing and managing appropriate processes
managing the underlying trade-offs between attributes measuring performance,
the implications of associated risk.
Best practice in project management is therefore concerned with the management of uncertainty that matters to the project in an effective and efficient manner. The requirements for an effective risk management process therefore include the project context and characteristics of all participants. Project contexts are characterised by the nature of the project, the immediate working environment, and the identity and actions of other participants.
Project risk management from this perspective aims to improve decision making through the reduction of uncertainty, the identification, and analysis of specific risks in relation to enterprise goals and constraints, and implementation of a risk programme of mitigation or control response dependant on the criticality of that risk and participants risk tolerance. The implementation and effectiveness of the response is then monitored and measured and adjustments made where appropriate. The purpose is therefore not to necessarily eliminate all risk but rather to remove avoidable risk, reduce uncertainty and retain a desired level of intrinsic risk. Key actions to reduce intrinsic risk include
ensuring adequate direction and participation from participants and stakeholders,
building a focus on delivery of value,
explicit management of resources including but not limited to infrastructure, knowledge and contractors,
ensuring appropriate delivery capability,
efficient communication mechanisms,
a risk management approach that incorporates benefits, cost and shared riskreward structures.
The conventional stages of risk management are typically represented by a six phase approach namely risk management planning, risk identification, qualitative risk analysis, quantitative risk analysis, risk response planning, and risk monitoring and control.
Risk management planning is an iterative process throughout a project and involves the frequent review project objectives and technical description, project assumptions, roles and responsibilities which form the basis for a risk management plan. The project context includes the environment, project characteristics, and organisational culture drivers of participants. These in turn influence the risk management process to be implemented. This phase requires the explicit statement of inclusion of both opportunities and threats with detailed documentation of opportunity management processes.
Risk identification is an iterative organised process for identifying risk events which may affect the project. It repeated at different phases of the project life cycle. There are a number of techniques for risk identification including, but not limited to, brainstorming, checklists, prompt lists, questionnaires, and Delphi groups as well as various diagramming approaches. The techniques may be used to identify both opportunities and threats. Additional approaches include a strength, weaknesses, opportunities and threats (SWOT) analysis, constraints and assumptions analysis or force field analysis to identify positive and negative influences on the achievement of objectives.
Identified risks are then assessed qualitatively by assigning values to an event probability and consequences as a basis for determining a qualitative risk factor. The most common technique is a two dimensional probability-impact matrix that allows the relative significance of the risk to be ranked on a high, medium, or low impact basis. This allows independent assessment of the probability and consequence of a risk as well as the qualitative definition of the basis for the risk and its risk level. A double sided probability-impact matrix is suggested to separate out opportunities and threats using the same technique to complement the qualitative risk assessment method.
Quantitative risk analysis involves the determining the probability of the incurrence of a risk, assessing the consequences of the risk and combining the two to identify a risk level using tools such as Monte Carlo analyses and decision trees. Several factors complicate the analysis including possible multiple effects on a number of systems by a single risk event and false impressions of precision and reliability through the deployment of mathematical techniques. The purpose therefore is to assess the overall level of risk exposure, to highlight specific areas of risk and to develop responses to that risk. The same quantitative techniques can be deployed to take account of opportunities and threats in the context of uncertainty measurements in terms of time and cost as well as the probabilistic combination of individual uncertainties. This is especially true because ranges of variables and associated probabilities are calculated and could be assigned best case (minimum optimistic) or worst case (maximum pessimistic) estimates to include threats and opportunities.
The risk response planning phase is the identification of the course of action or inaction as a response to identified risks that is appropriate, affordable, and achievable. Response methods typically optimally balance risk with other factors such as cost and time, and are driven by the unambiguous allocation to responsible individuals for implementation and monitoring purposes. Risk responses are usually grouped according to the intended effect on the risk being managed. Responses to risks generally fall into one of four major categories avoid or eliminate the uncertainty, transfer to an alternate stakeholder better equipped to manage the risk, mitigate by reducing the size of the risk, or accept the risk on an active, contingent, or passive basis. These risk responses are more appropriate to threats than opportunities. Four opportunity response strategies are exploit by increasing the probability of it happening on an aggressive basis, share the opportunity with other stakeholders to maximise the opportunity, enhance the opportunity by seeking to increase the probability and impact to reap the benefit and lastly, ignore, or by means of a contingency plan or reactive approach should the opportunity materialise. This requires a clear and unambiguous understanding of the level of risk being borne by each participant and an assessment of the capacity of that participant to manage the risk in the context of the project environment. Lastly, the motivation from a behavioural perspective is a key consideration in capacity to manage risk.
Risk efficiency is defined as the minimum risk decision choice for a given level of expected performance. It is common practice in project risk management to focus on risk events rather than the accumulated effect of all risk events and all other sources of uncertainty which influence decision choices. By implication, the conventional risk management processes outlined in part one do not highlight the impact of multi-party contracts in projects which may arise due to difference in perception of risks and uncertainty.
The traditional risk allocation process has involved a one sided attempt to transfer risk to another party, more typically to a contractor on a contractual basis. The defensive strategy followed by a contractor is to set off through contingency charges, conservatism in servicing the contract or accepting project alternatives and resolving disputes through legal process. Inappropriate risk allocation may therefore occur across a multi-party project environment. The traditional project process has dealt with the downside of risk to contractors that include such areas as negligence, insurable risk, economic benefit, and project efficiency. The upside potential and matching of risk and reward (opportunities) has been generally ignored. The principle of efficiency ignores risk pricing or risk tolerance of the parties and does not distinguish between controllable or uncontrollable risks.
A common qualitative approach to risk allocation across multiple parties is a standardised contract specifying obligations and relief such as extensions on completion times based on a risk allocation matrix and separated between external and internal project risks. The underlying principle is that of risk distribution so that the total effect of the total expected cost is minimised. This approach limits the degree of risk sharing and the ranking in terms of cost efficiency and satisfaction. Quantitative methodologies compensate for this inadequacy with an attempt to optimally allocate risk based on co-operative or competitive risk approaches. Co-operative risk allocation assumes a joint agreement on acceptable risk and hence establishes contingency cost elements based on decision theory, simulation, or co-operative game theory. Competitive risk allocation comprises the implementation of individual stakeholder strategy without due consideration on the impact of other project stakeholders and is typically applied in self insured models where the contractor acts as a quasi-insurer. A combined model allows for negotiation space that is used in Private Finance Initiatives (PFI) assumes optimal risk allocation. The models flaws are the assumption of complete information, the disclosure of risk tolerance by all parties and the basis for establish allocation ratios of variable operating costs and profits. Nonetheless, the model can act as a benchmark through which to evaluate feasible risk allocation.
Risk tolerance or willingness to accept risk is based on a general attitude to risk, the perception of the project risk and actual capacity to accept and manage the associated risks and uncertainty. Risk perception is the subjective understanding of exposure to loss or damage to people, property, or interests as a basis for doing business and offering services. The risk process includes potential risk, actual occurrence, and impact. Various mechanisms such as psychometric diagrams exist to map opinions about risk but this focus is largely upon identification of risk as opposed to analysis and response processes. In subjective assessment, bias is inevitable. The human judgmental ability is often defected by various biases, which distort the correct perception.
Uncertainty management in a multi-party environment emphasises the need to understand and manage sources of project uncertainty. One mechanism is a risk uncertainty map. The map concept was developed on construction industry related literature and real world projects. Significantly, by accumulating the experience and lessons from past projects and updating the structure, the riskuncertainty map is considered as knowledge base used for better dealing with risks and uncertainties.
It is clear that conventional project management processes has limitations in terms of adjusted project processes that deal with uncertainty in the opportunity elements of an expanded definition of risk as well as weaknesses in risk allocation in a multi-party environment. An integrated model to manage uncertainty in the broader sense is necessary and is an important element to be considered in a successful risk management approach.
The underlying premise of the risk management process is to maximise stakeholder value and achieve an optimal balance between uncertainty, risk, and opportunity. A project has a defined beginning and end, is designed to achieve a specific objective and consumes funding and resources to achieve that end. It can be argued that the nature of project risk management fills a narrower spectrum of risk management which is more tactical than strategic in nature, and is structured within a broader enterprise uncertainty management programme.
The application of uncertainty management to strategy requires a shift in thinking and is analogous to the historical views on the direct relationship between cost and quality which Japanese manufacturers turned around with innovative manufacturing methods, showing that improving the system could actually reduce costs whilst improving quality.
Uncertainty management as a methodology in enhancing strategy formulation can provide a valuable function in a hypercompetitive environment and enhance effective and efficient decision making. An example of the application of uncertainty management in a corporate strategy formulation process is that represented in Conrads tale in Managing Project Risk and Uncertainty. The analysis operates within three time horizons (short, medium and long term) and considers the separability and interdependence of each of the time lines. The tale considers uncertainty with respect to long term demand growth for a power company services in the context of political, environmental, and economic drivers compared against medium term planning for new capacity relative to the costs of not meeting demand growth, versus the costs associated with developing capacity in anticipation of an uncertain future demand. The conclusion was a lag approach to developing capacity from a cost benefit perspective. The focus of the case is on the framework development that allows alternative short, medium, and long term strategy formulation and considers the linkages as a means of synthesising both bottom-up and top down analyses. The recommended six phase approach is constructively simple, and iterative in nature. It incorporates a decision support approach as opposed to decision making, enhances skills in decision making, involves synthesis from a holistic perspective, requires interpretation whilst stimulating creativity, utilises a facilitative approach that embraces corporate learning, and can accommodate both specific and general processes. The constructively simple approach to decision making is relevant in decision processes such as strategy formulation where the context involves high levels of uncertainty.
Arguably therefore, uncertainty management can support strategic management processes at enterprises whilst maximising value to stakeholders and aligning risk appetite with strategic alternatives and opportunities.
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