part 7 PowerPoint Presentation by Charlie Cook Copyright © 2003 South-Western College Publishing. All rights reserved. All rights reserved. Risk and Insurance 24 Financial Management in the Entrepreneurial Firm 12e

Copyright © by South-Western College Publishing. All rights reserved. 24–2 Looking Ahead After studying this chapter, you should be able to: 1. Define risk and explain the nature of risk. 2. Explain how risk management can be used in coping with business risks. 3. Describe the risks associated with different types of assets, both physical and human. 4. Explain the basic principles used in evaluating an insurance program and the fundamental requirements for obtaining insurance. 5. Identify the different types of insurance coverage.

Copyright © by South-Western College Publishing. All rights reserved. 24–3 What is Risk? Risk –The chance that a situation may end in loss or misfortune. Market Risk –The uncertainty of a gain or a loss associated with an investment decision. Pure Risk –The uncertainty associated with a situation where only loss or no loss can occur—there is no potential for gain (only downside).

Copyright © by South-Western College Publishing. All rights reserved. 24–4 Risk Management –Ways of coping with risk that are designed to preserve assets and the earning power of a firm. The Process of Risk Management Step1:Identify risks. Step 2:Evaluate risks. Step 3:Select methods to manage risk. Step 4:Implement the decision. Step 5:Evaluate and review.

Copyright © by South-Western College Publishing. All rights reserved. 24–5 Methods to Manage Risks Risk Control –Minimizing potential losses by avoiding or reducing risk. Risk Avoidance –Preventing risk by choosing not to engage in hazardous activities. Risk Financing –Making funds available to cover losses that cannot be managed by risk control.

Copyright © by South-Western College Publishing. All rights reserved. 24–6 Methods to Manage Risks (cont’d) Risk Transfer –Buying insurance or making contractual agreements with others to transfer risk. Risk Retention –Choosing—whether consciously or unconsciously, voluntarily or involuntarily—to manage risk internally. Self-Insurance –Designating part of a firm’s earnings as a cushion against possible future losses.

Copyright © by South-Western College Publishing. All rights reserved. 24–7 Tools For Managing Risk TABLE 24-1

Copyright © by South-Western College Publishing. All rights reserved. 24–8 Fig 24-1 The Wheel of Misfortune

Copyright © by South-Western College Publishing. All rights reserved. 24–9 Risk Management and the Small Firm Risk management differences from large firms: –It is more difficult for small firms to get insurance coverage. –Large firms can assign responsibilities for risk management to a specialized staff manager. –Risk management is not something that requires immediate attention.

Copyright © by South-Western College Publishing. All rights reserved. 24–10 Classifying Risk by Type of Asset Property Risks FireFire Natural Disasters “Acts of God” Customer Risks Employee Dishonesty Competition from Former Employees Personnel Risks On-Premises Injury Product Liability Burglary and Business Swindles Loss of Key Executives Bad Debts ShopliftingShopliftingBankruptcyBankruptcy

Copyright © by South-Western College Publishing. All rights reserved. 24–11 Insurance for Small Business Basic Principles of a Sound Insurance Program –Identify insurable business risks  Workers’ compensation and automobile liability insurance are required by law. –Limit coverage to major potential losses  Avoid overspending insurance resources. –Relate premiums to probability of loss  Insure most improbable but critical losses first.

Copyright © by South-Western College Publishing. All rights reserved. 24–12 Requirements for Obtaining Insurance The risk must be calculable so that premiums can be calculated. The risk must exist in large enough numbers to allow the law of averages to work. The insured property must have commercial value. The policyholder must have an insurable interest in the property or person insured.

Copyright © by South-Western College Publishing. All rights reserved. 24–13 Types of Insurance Commercial Property Insurance –Coverage that protects against losses associated with damage to or loss of property.  Coinsurance clause Business Interruption Insurance –Coverage of lost income and certain other expenses while the business is being rebuilt. Dishonesty Insurance –Coverage that protects the firm against employees’ crimes.

Copyright © by South-Western College Publishing. All rights reserved. 24–14 Types of Insurance (cont’d) Surety Bonds –Coverage that protects against another’s failure to fulfill a contractual obligation. Credit Insurance –Coverage that protects against abnormal bad-debt losses.

Copyright © by South-Western College Publishing. All rights reserved. 24–15 Commercial Liability Insurance