part
7
Financial Management in the
Entrepreneurial Firm
24
Risk and
Insurance
PowerPoint Presentation by Charlie Cook
12e
Copyright © 2003 South-Western College Publishing.
All rights reserved.
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.
24–2
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).
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24–3
Risk Management
• 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:
Step 2:
Step 3:
Step 4:
Step 5:
Identify risks.
Evaluate risks.
Select methods to manage risk.
Implement the decision.
Evaluate and review.
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24–4
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.
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24–5
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.
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24–6
Tools For Managing Risk
High Frequency
Low Frequency
High Severity
 Risk avoidance
 Risk reduction
 Self-insurance
 Contractual agreements
Low Severity
 Risk reduction
 Risk retention
 Risk retention
TABLE 24-1
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24–7
The Wheel of
Misfortune
On-Premise
Injury
Fire
Product
Liability
Natural
Disasters
Customer
Risks
Property
Risks
Bad Debts
Personnel
Risks
Shoplifting
Employee
Dishonesty
Loss of
Key
Executives
Burglary and
Business Swindles
Competition
from
Former
Employees
Bankruptcy
Fig 24-1
Copyright © by South-Western College Publishing. All rights reserved.
24–8
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.
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24–9
Classifying Risk by Type of Asset
Property Risks
Customer Risks
Personnel Risks
Fire
Employee
Dishonesty
On-Premises
Injury
Natural Disasters
“Acts of God”
Competition from
Former Employees
Product Liability
Burglary and
Business Swindles
Loss of Key
Executives
Bad Debts
Shoplifting
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Bankruptcy
24–10
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.
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24–11
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.
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24–12
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.
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24–13
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.
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24–14
Commercial Liability Insurance
Type
Coverage
General Liability Insurance
Protects against lawsuits brought by
customers.
Employer’s Liability Insurance
Protects against lawsuits brought by
employees who suffer injury.
Worker’s Compensation
Insurance
Obligates the insurer to pay employees
for injury or illness related to employment.
Key-Person Insurance
Protects against the death of a firm’s key
personnel.
Disability Insurance
Protects against disability of a firm’s
partner or other key employee.
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24–15