2 Flashcards
(41 cards)
What is Value Based Management (VBM)?
VBM is a management approach that focuses on maximizing shareholder value by using financial performance measures that include a capital charge for the use of capital. (Dekker et al, 2012)
VBM measures are based on residual income and aim to align internal goals with the maximization of shareholder value. (O’Hanlon and Peasnell,1997)
How do VBM measures address limitations of traditional financial measures?
VBM measures overcome limitations by accounting for the cost of capital in goal setting, capital budgets, and managerial compensation.
Traditional measures may incentivize projects that increase earnings without considering efficient capital and asset use.
What is Return on Invested Capital (ROIC)?
ROIC is calculated as Net Operating Profit divided by Invested Capital, becoming a VBM measure when compared to the cost of capital.
What is Residual Income (RI)?
RI is the excess operating profits over the capital charge based on investment opportunities of similar risk, calculated as Operating Profit minus Cost of Capital.
What does Economic Value Added (EVA) represent?
EVA measures a company’s financial performance based on the residual income concept, calculated as Adjusted Operating Income minus Capital Charge.
(adjustments include deferred income tax reserves, the LIFO reserve, treatment of intangible assets; e.g. R&D, goodwill amortisation)
What are the advantages of using EVA?
Advantages of EVA include:
* Summarizes wealth creation
* Encourages consideration of asset use in decisions
* Reflects management performance.
What are the limitations of EVA?
Limitations include:
* Time-consuming cash adjustments
* Susceptibility to accrual distortions
* Not predictive of future performance
* Most applicable to asset-intensive companies.
What is the cost of capital (WACC)?
WACC represents the return required by investors based on their assessment of forecast future cash flows and the risk of those flows.
How does financial accounting relate to risk?
Financial accounting primarily addresses returns through profit statements and is considered a risk-ignorant measure, weakly reporting on financial risk component ratios like gearing interest cover but not business risks.
What is the difference between risk and uncertainty?
Risk involves uncertain events with measurable probabilities and impacts on achievements of objectives, while uncertainty is when probabilities are unknown and cannot be measured due to lack of data.
What is the purpose of risk assessment?
The purpose is to measure risk based on probability and severity and prioritize risks for further analysis and management. Also, then Allocate the risks to a quadrant on a risk map.
What are the components of the COSO (2004) ERM framework?
The components include:
* Internal Environment: is about risk management philosophy, risk appetite of the firm, integrity and ethical values.
* Objective Setting: objectives are needed before events potentially affecting their achievement can be identified.
* Event Identification
* Risk Assessment
* Risk Response
* Control Activities
* Information and Communication
* Monitoring.
What does risk reporting entail?
Risk reporting confirms the achievement of policy benchmarks and informs stakeholders about the effectiveness of risk management policies.
Fill in the blank: Risk is measured by a combination of the probability of a perceived threat or opportunity occurring and the ______.
magnitude of its impact on objectives.
True or False: EVA applies to all types of companies equally.
False.
What is the internal environment in the context of risk management?
It is about risk management philosophy, risk appetite of the firm, integrity and ethical values.
Why are objectives necessary in risk management?
Objectives are needed before events potentially affecting their achievement can be identified.
What are the four types of objectives in ERM according to COSO, 2004?
- Strategic: High level goals in line with the mission and vision (e.g. gain a specified market share)
- Operational: Effective use of resources to achieve the pre-identified targets (e.g. launching a new product line)
- Reporting: Reliability of reporting
- Compliance: with applicable laws and regulations
How does ERM help entities achieve their objectives?
- Aligning risk appetite and strategy
- Enhancing risk response decisions: Risk avoidance, reduction etc
- Reducing operational surprises and losses: By helping to identify events which can cause associated costs or losses
- Identifying and managing multiple and cross-enterprise risks: Firms experience different risks in different aspects of the firm and resonses are needed so they can take into account any interrelation between all risks
- Seizing opportunities: Considering all potential events, and then identifing and realising opportunities
- Improving deployment of capital: obtaining robust risk information allows management to effectively assess overall capital needs and enhance capital allocation.
What are two disadvantages of ERM?
- Complex to administer
- Each company has its own unique set of risk and potential rewards
What are some common types of risks?
- Commercial: Volume risk, Margin risk, Management risk
- Financial: Interest rate risk, Commodity risk, Credit risk, Liquidity risk
- Operational: People risk, External events and Catastrophic risk, System failures
What are some drivers of risk and uncertainty?
- Globalisation & Competition
- Technology
- Changing markets
- Regulation
- Human factor
What are the top five risks identified by Vodafone in their 2019 Annual Report?
- Cyber threat and information security
- Adverse political and regulatory measures
- Global economic disruption/ adequate liquidity
- Geo-political risk in supply chain
- Digital transformation and simplification
What factors affect a company’s risk appetite?
- Industry
- Culture
- Competitors
- Objectives pursued
- Financial strength and capabilities
