Understanding risk in corporations

- Businesses make money because they take risks, but if they take on too much risk, they could go out of business. There is an important balance that corporations have to strike between upside and downside risks, and this is one of the core foundations of corporate financial risk management. Upside risks present opportunities for profits, but downside risks present the potential for losses. Effective risk management is important for helping companies capture both the upside opportunities and limit downside risks. In the same way that a prospector, in the gold rush era would have bought a pickax to mine for gold, there was risk involved. Maybe at the end of the day, he would have found gold, or maybe at the end of the day, he would just have a pickax. Any modern business functions under similar conditions. Businesses take risks all the time to try to capture margin, build their business, drive profits, and achieve growth, and yet, if that prospector took everything he had and spent it on that pickax, there isn't much risk management there. If he doesn't find gold quickly, he could find himself in a very bad place. Maybe a better strategy would have been to risk a little bit but not everything. For a corporation, sometimes it's all or nothing, but there should be a good understanding of the risks involved. Knowing the downside risks is a critical first step. You need to know what's at stake. By and large, entrepreneurs are known as a risk taking class. Most risks a little at first until there's evidence that a business can be built, something known as proof of concept, and a proof of concept is when you first prove something can work. A great example of this was when the Wright Brothers tested their first plane in Kitty Hawk, North Carolina. That plane wasn't the Concord trying to break the sound barrier, one of Top Gun F-14s. It was a wooden plane they were just trying to get off the ground for a few seconds. Now, that short time off the ground provided proof that the concept of flight could work or the proof of concept, but even if a business is careful and risks are taken slowly, there are internal and external factors that can threaten to upend almost any business. There's a joke people like to tell about CEOs, and I've seen it shown in a few different ways, but in each case, the presentation is similar. The peak goal for most CEOs is to go to Davos, a winter meeting of global leaders, politicians, and cultural icons in the Swiss Alps each January, and while that may be the top goal, the first goal is more fundamental. Just don't get fired. For a corporation, the internal and external risks people talk about are not usually focused on finding gold nuggets or going to Davos. They're about going out of business. When people talk about corporate risk, they're focused on the negative risks that need to be avoided. Of course, sometimes there is the potential to turn downside risks into upside opportunities, and we'll dig into those in other videos, but normally when people talk about corporate risk, know that they are talking about minimizing, mitigating, eliminating, offsetting, or otherwise reducing negative risks that could make a company lose money or go out of business. The way companies do this, the structured way they protect themselves from downside risks is called risk management. So whether you're a modern day prospector, an entrepreneur dreaming of flying, a CEO dreaming of Davos, or anyone in between, know that along with the upside risks for your company, there are downside risks that require proper risk management.