Risk Appetite, Tolerance and RBC What do they mean?

Is it all the same? Risk Appetite Risk Tolerance Risk Bearing Capacity

What is it? Risk Appetite Propensity to take risk Risk Tolerance Ability to take risk Risk Bearing Capacity Absolute financial measure to survive risk

Risk Appetite Totally subjective Based on perceptions Personal May be measurable or not May change very regularly as environment changes

Risk Tolerance Still Subjective Measurable Criteria need to be identified Criteria need to be agreed Must take note of business dynamics

Risk Tolerance Measured in terms of “deviation from business objectives” Prioritised according to criticality to company Both upside and downside are identified and measured (each with own identity) KPI’s

Risk Tolerance Dimensions Enterprise Business unit Region Product line Brand Customer

Risk Tolerance Dimensions Time Risk type Change Value Outcome Objective

Risk Tolerance Dimensions Reward Interest Asset Value Action Change Agents Influence

Risk Tolerance Dimensions Time Probability Position Information

Reward Strategic goals Financial targets Production targets Marketing & sales targets Organisational objectives Business objectives

Interest Shareowners Suppliers Customers Employees Authorities Communities Business Partners Industry Bodies

Assets Dynamic assets Value based assets Legal assets Human assets Physical assets Product based assets Intellectual assets Financial assets Static assets

Value Financial value Strategic value Competitive value Time value Replacement value

Action Incoming corporate actions Corporate financial actions Corporate process actions

Change Agents Competitive Financial Fiscal Operational Intellectual Legal

Change Agents Reputation Social Human Environmental Natural Technological Political

Influence Accumulation Aggregation Arbitrage Background Complexity Correlation Criticality Cycles Dependency

Influence Diversification Duration Interdependency Liquidity Proximity Reliability Tolerance Volatility Vulnerability

Time Cyclical factors Seasonal factors Timing Regional cycles Duration Simultaneity

Probability Likelihood Statistical probability Correlation Volatility Aggregation Timing Relative frequency

Position Flexibility Liquidity Crisis response Contingencies Control/influence

Information Value at risk Earnings at risk Cash flow at risk Yield curves Risk capital Stability ratios Liquidity ratios

Some examples % of Revenue % of EBITDA % of Adjustable earnings % of Debt Service cover headroom % Leverage

Some examples Employee safety Staff Turnover Management turnover Environmental incidents Machinery breakdown incidents Ethics (fraud, bribery incidents) Training as % of Revenue Employee engagement scores Average machinery age R+D spend as % of turnover

Risk Bearing Capacity Definition: RBC is a prediction of the enterprise’s ability to endure losses and the effect such losses may have on the enterprise’s value and /or its ability to continue with its activities RBC is a monetary value which is used as a yardstick, measuring the maximum loss the enterprise can endure, without exposing it to the point where its existence and survival is under threat, given an equivalent loss.

RBC Methodologies Net Working Capital Net Working capital = Current Assets – Current Liabilities 25%

RBC Methodologies Quick Asset Value Quick Asset Value = Current Assets – Inventory Quick assets = trade debtors +bank account 25%

RBC Methodologies Coverage Ratio Coverage ratio : Times-interest-earned ratio How many times the enterprise’s operating income covers its debt-service charges T-I-c-v= earnings before interest and tax – interest expenses 10%

RBC Methodologies Annual Cash Flow Generated Annual Cash flow Value = Annual cash flow-interest paid annually on long term debt 10%

RBC Methodologies Surplus Cash Surplus cash (free cash) = after ops activities, interest, taxes, dividends and before investment 10%

RBC Methodologies Total sales Total sales from income statement 5%

RBC Methodologies Net Income Net Income = Profits after tax and interest 10%

RBC Methodologies Retained Earnings Earnings after dividends 10%

RBC Methodologies Fixed Assets Total value of Fixed Assets 5%

RBC Methodologies Distributable Reserves = Accumulation of profits retained and reinvested 10%

Risk Tolerance Value Pick a selection of RBC values Some may be negative or not applicable at all Select as many as possible Calculate the Average