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RISK IN PROJECTS
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Risk in Projects
Project covers projections and
estimations based on certain
assumptions There is always an element ofrisk and
uncertainty involved in a project
No project is completely free of the
element of risk and uncertainty
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Risk and Uncertainty in Projects
Risk signifies the possibility of adverse
happening
Risk is change in project outcome that affects
revenue /profitability /cost of project adversely
Risks arise because of the inability of the
decision makers to make good forecasts and
estimates
Agricultural Projects are exposed to variety of risks
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Risk and Uncertainty
According to the recent view risk ismeasurable while uncertainties notmeasurable
Risk is defined as a situation when allpossible outcomes are known for a givenmanagement decision and probabilityassociated with each possible outcome is
also known Risk is measured through probabilityconcepts
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Risks that can be faced by a
Banker May be expressed by following functional relationshipCredit risk = f [BR,FR,DR, Cr, Fr]
BR=business risk
FR=Financial risk
DR=default risk
Cr=Cost based risk
Fr=Fiduciary risk
It is difficult to assign a particular coefficient to each
of the factors as the degree of risk varies from caseto case
A banker needs to have an integrated holistic approachtowards all the risk factors while taking a creditdecision
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Business riskBroad elements are a)Criticalinput risk b)-Operational risk c) Productionprocess risk d) Marketing and selling risk e)Labour risk
Financial riskIt depicts whether the co. wouldbe in a position to generate sufficient profit afterpaying debt interest to finance satisfactorydividend besides ploughing back adequate
quantum into the business. Primary indicatorsare debt equity ratio.total borrowing ratio etc
Default riskThe risk can be determined by a)amt of cash flow b) Timing of cash flow
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Cost base riskCan be based on the twocategory of costs a) Static and b) DynamicFormer representing those which do not bring
positive value to the firm while the latercontributes to the growth and profitability
Fiduciary RiskFacilities such as LC/LG arethe non fund based facilities offered by the
banks This results in unexpected outflow offunds consequent upon invocation of bankguarantee or inability of the client to retire thebills under LC on due date
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Types of project risks
Financial Risk
Not in a position to provide the expected return to
investors of equity capital
Business Risk Not achieving the expected earnings from the project
Systemic risk
System-wide or economy-wide risk
Unsystemic risk
Project specific risk
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Risk in foreign projects
In addition to normal project related risks,
there are risks due to:
Economic factors Foreign exchange fluctuations, taxation andinflation
Political factors
Govt policy in general Sudden changes in state policy in regards
Taxation, tax incentives, availability of finances,
repatriation of profits, wage rates, dividend rates etc
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Sources of Risk
Production RiskProduction practices arestandardized in industrial production Such typeof relationship does not exit in agri production.Output is subject to change due to weather,
disease, insects ,weeds and inadequatetechnology
Yield variations are due to many factors. Someare under control while some others are notunder the control of management
Weather risk and technical risk are the mostimportant components of production risk
Price trends also cause production risk
Change in technology in a particular place may
also have bearing on production risk
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Price risk or Marketing risk---Production ofcrops and livestock is influenced by prices in themarket which are beyond the control of farmers
Prices of commodity vary from year to year Financial RiskIncreases with increase amt of
borrowed money in the farm businessUncertainty arises due to the changes in future
interest rates and fiscal policies of RBI A careful analysis is to be made considering allthe types of risk including their sources to followthe relevant management practices
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Measures to Manage Farm Risk
DiversificationSelection of suitable crop and livestock enterprisesis the first step in diversification .Diversification helps to givedifferent products rather than a single product. Income variability canbe lessened through diversification
Stable enterprise should be preferred rather than risky enterprise
particularly in situation of farm risk InsuranceInsurance is their to reduce production risk andfinancial risk .Farm assets are insured against theft burglary fire orany other damage.Decision is judged by the following equation
Y=F[0-r] - P where Y=Profit obtained by going for insurance
O=opportunity cost for financial resources in terms of % ,F=financial
reserves required r=interest earned on fin. reserves
P=ins. premium paid by the farmer
Agronomic practicesCrop rotations, suitable varieties ,tillage,mulching etc
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continued
Selecting a less risky enterpriseCrops of long gestation periodthe risk is higher--the additional risk is the risk of fall in the value ofmoney and thus fall in real value of net return
Adoption of production methods with low variabilitySowing bylabour or by machineVarious inputs have alternatives--work can
be performed in different ways Forward contracts and Price supportSugarmills contracting thefarmersPrice support given by Govt.-- Risk covered is less inoilseeds and pulses due to non availability of support price orfluctuation in market price
Asset structurecapital assets in liquid form is less risky to fallback upon in case of loss .Having pair of bullock is more risky thanhaving a tractorasset structure is important to determine thedegree of risk
Capital RationingA farmer should ration his investment amongdifferent crop and equipment
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Statistical measures of risk
In statistics, risk is defined as the degree ofvariability of possible outcome over time
In projects risk is the variability or range of NetPresent Values
NPV depends on initial outlay, net cash flowsduring the life of the project, and the discountingrate.
Statistical measures such as probability
distribution, expected value, standard deviation,coefficient of variation, etc are useful inestimating the risk in projects
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Conventional Measures of Risk
Based on experience of dealing with the projects as wellas personal understanding and the judgment of thesituation examples include
Conservative estimate of Net Cash Flows
Reduce net cash inflow by 10 % or increase net cashoutflow by 10 % at the time of computing the NPV ofthe project
Project Classification
Higher rate of discounting in case of high risk projects
and lower rate of discounting in low risk projects ShorterPay-back Period
Prefer shorter pay-back period in high risk projectsand longer pay-back period in low risk projects thusweeding out high risk projects
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Continued---
Consideration of more than one estimates
Examine different likely situations expected such as
pessimistic, most likely and optimistic or low risk
condition take average as working estimate Over-all certainty index
Used to cover element of risk in projects
Eg: Power, Raw material and Threat from competitors
are risks in a project-Quantify these risks individuallyand come up with an index for the project
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Measurement of Risk in Projects
Pay back period
Risk adjusted rate of return
Discounting rate = risk free rate + risk premium
Certainty equivalent coefficient
Ratio of certain cash flow to risky cash flows
Risk Index
Use of composite score of certain ratios viz. equity tototal funds ratio; trend of profit over three years etc
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Risk Index (Tamari Horm)
No Ratio Max. point Range
1 Equity to total funds 25 50%
2 Trend of profit over three
years
25 Loss in all 3 yrs Profit
in all 3 yrs w/ rising trend3 Current ratio (current assets
:current liabilities)
20 2.00
4 Ratio of value of production
to total inventory(RM+WIP+FG)
10 Lower quartile upper
quartile
5 Ratio of sales to tradereceivables
10 Lower quartile upperquartile
6 Ratio of production to
working capital
10 Lower quartile upper
quartile
Total 100
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Sensitivity analysis
Highlights effect of adverse variations ineach of the significant variables affectingcash flow in a project
NPV can be assessed under the followingconditions:
Sales volume declines
Cost of production is increased Labour cost, Minimum wages go up
Economic life of project reduces
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Limitations of Risk Analysis
Quantitative analysis of nature and extent of riskin a project has following limitations: Estimates are highly subjective the terms like high
or low do not have the same meaning in all places,situations or persons
Element of subjectivity in judgment overestimatecosts during performance evaluation or overestimaterevenues when there is no performance evaluation
More reliance on data and analysis than personalexperience to avoid responsibility (ex: marketingperson relying more on market survey than personalexperience)
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Agri Business Risk
RISK - arises from a broad set of business
procedures and activities which may translate to:
Unanticipated losses ,resulting from the portfolio business
(e.g., credit, market, liquidity)
or
Potential and actual losses resulting from hazard-related
events (e.g., theft, fire, environmental impairment)
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Risk Categories in Agriculture
Market Risk -
Exposure of product values to changes in industrycondition and expectations (e.g., inflation)
Price Level Risk
susceptibility of products values to supply-demand
configuration,[ business cycle,] competitionand substitution.
Customer Preference Risk
susceptibility of products availability and design to
particular customer needs, quality,performance expectations, class, tasteand fashions.
Money Rate Risk
susceptibility of interest , income and expenses ,tochanges in external rate environments
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Contd
Financial RiskExposure of balance sheet accounts to inherent financial optionssuch as loan repayments, early fund withdrawals, asset conversioncycles. etc.
Liquidity Risk
Susceptibility of an entitys funding ability to perceived changes ,in
the entitys condition. Payment obligation assurance, Cash flow toretain, buyer-suppliers confidence ,staff payments etc
Capital Risk
Susceptibility of capital/investors to changes in rates [interest,exchange, ] money markets and other areas of risks.
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Contd.
Operational Risk
Exposure of projects to systems failure, organizationalinefficiency and technological obsolescence
Systems Risk
Susceptibility of projects well-being to absence of measuring tools,
benchmark standards, information adequacy and controls [day to day
operations]
Organizational Risk
Susceptibility of projects ,to structural dysfunction, skills inadequacy,
personnel turnovers and integrity [strike, staff leaving]
Managerial Risk
Susceptibility of projects to proper decisions of
Management [recession period]
Technology Risk
Susceptibility of projects to obsolescence of technological hardware
and programs ; e.g . Development in bio-tech inputs affecting
services/product preferences.
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Contd
Credit Risk
Exposure of the fund provider to possible non-collection and/or
incurring losses due to default .
Loan Recovery Risk
Susceptibility of credit to the quality of project analysis and
eligibility of borrower in terms of character and competence to
properly handle credit and honour its terms
Legal Risk
Susceptibility of lenders to the effects of incomplete and/or
unenforceable loan documents
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RISKMANAGEMENT IN
Agri-Business
Risk Areas in Agri-business
a. Marketb. Financial
c. Operations
d. Credite. Environment
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High risk profile of food processing industry:
1.Lack of flow of credit from the financial institutions
2.Low margins
3. High perishability
4. Uneasy Access to seed capital and working capital
5. Indian Products, yet to establish in International markets.
6.As per the WTO meeting the quality standards has been a major
hurdle to compete in the domestic and international markets.
7.Weak data base and Market Intelligence
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Support from Government
To Reduce Risks and PromoteCommercialisation
a) Exim . Policy
b) Schemes of Ministry of Food Processing
Industries, NHB,NHM
c) Technology Missions - Soya, Cotton, Rubber
d) Trade Promotion bodies - APEDA, MFPEDA
e) Commodity Boards - Silk, Spices, Coffee,Tobacco, Tea
f) Market development-/Regulated Markets/
Model act / Futures Trading Exchanges
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Risk Management- Mitigation
Attention to effective low cost technology Formulating convincing projects for Banks -
For credit support Follow financial discipline
Raw material supply Own back up Ware
house , cold storage etc.
Contract farming arrangements Tie ups with
farmers
Not to rely totally on export market exploitdomestic market also
Flexibility & adaptability approach
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Contd
Not to depend entirely on foreign technology,imported inputs
Maintain continuous & quality supply
Wherever possible take benefit of capitalinvestment subsidies, Insurance coverage etc
Prefer industries in Agro Export Zones
Diversify risks by proper product mix
Make use of innovative supply chain Follow GAP, Codex norms, strict quality
control
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STRENGTHENING LINKAGES BETWEENPRODUCER AND CONSUMER
EVALUATECOMMERCIAL AGRICULTUREPROJECTS ON HOLISTIC BASIS
PERFORMANCE OF VARIOUS CRITICALFUNCTIONS TO BEALLOCATED
AS PER ABILITY TO PROVIDEHIGHESTEFFICIENCY AT LOWEST COST
WHERE NECESSARY CONSIDER ALLPLAYERS IN VALUECHAIN
CREATE THECRITICAL MASS
DEVELOP AND SYSTEMATISE SUPPLYCHAIN,LOGISTICS AMD INFRASTRUCTURE
New Perspectives..
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