How to Measure Risk in Your Business.

Capital Budgeting
posted by DERRILL HIOTT , Mar 17, 2016, 2:17 PM
In my organization, we are always looking at altering our machining process to remove waste from the manufacturing process. However, in most all cases, it requires a machine with newer technology. Capital requests require planning and usually are not approved immediately. A machine with the capability to replace one or more machines, that could potentially reduce setup times and possibly headcount. A project like this may be an attraction to the bean counters and get approved more quickly. As indicated in an article by Sham Gad on Investopedia.com, the rate of return is always the key factor in the decision making process. “Once projects have been identified, management then begins the financial process of determining whether or not the project should be pursued. The three common capital budgeting decision tools are the payback period, net present value (NPV) method and the internal rate of return (IRR) method.”

“The payback period is the most basic and simple decision tool. With this method, you are basically determining how long it will take to pay back the initial investment that is required to undergo a project. The net present value decision tool is a more common and more effective process of evaluating a project. Perform a net present value calculation essentially requires calculating the difference between the project cost (cash outflows) and cash flows generated by that project (cash inflows). The internal rate of return is a discount rate that is commonly used to determine how much of a return an investor can expect to realize from a particular project.”
Reference(s):

Gad, S.(ND).Capital Budgeting: Capital Budgeting Decision Tools | Investopedia http://www.investopedia.com/university/capital-budgeting/decision-tools.asp#ixzz42YTLOsDE

posted by WAYNE YETMAN , Mar 17, 2016, 2:41 PM
In many businesses, capital budgeting involves replacing machinery or starting new process to replace old ones to make more money, or in other words, to make more money than the old process and still have the changes pay for themselves with savings or increase in sales/production. In my business, we have a issue that some may not see as a capital budgeting issue, but for us, it is. We are currently taking bids to paint our building and redo our landscaping. People may think this is just a cosmetic fix but in the hotel business, a better looking exterior can mean more business. It is a proven fact that many people will get their first impression of a hotel simply by the looks of the building and the grounds surrounding the property. If the property looks bad from the outside, then most likely it is bad in the inside and customers will drive away simply for that fact. Thus, we must take into account how must business we lose and how much we will gain simply by improving the exterior of our building and the surrounding property. We feel that we will gain up to 5 room rentals a week just because of the “better looks” of the property and thus increase our profit margin. Although I was not involved in the actually math process my owner did, after he explained what he thought the new looks would do, I believe he used the simple method of “payback period” which he figures it would take only 1 year to get back the investment of the changes to our exterior and since many of the changes such as new landscaping will hopefully only be a one time output of cash, they will not need to be replaced or redone on some type of regular basis.

I will admit this is a simple example of a capital budgeting issue, but in the past, I have had to make decisions on such items as new beds, new tvs, and even new furniture for our rooms, all of which were based on the cash it would cost us for the items and how long it would take us to recoup that output. In the hotel business, it is not all about machines or new process to increase incoming cash flow, it is about the items that make up the room for a guest and the building/grounds of the hotel.

posted by Tana Barnes , Mar 18, 2016, 8:20 PM
Capital budgeting is defined as the process of analyzing and ranking proposed projects to determine which project(s) is/ are worthy of an investment (Bragg, 2016). There are three different methods when deciding which project should be before others. The first method is throughput analysis. Throughput analysis determines the impact of the investment on the turnout of an entire system. The second method is the discounted cash flow analysis. This method helps mold the present value of all the cash flows that is associated with the project. The third method is payback analysis. This method computes how quick you can earn back on the investment.

Resource:
Bragg, S. (2016). Overview of Capital Budgeting. Retrieved from: http://www.accountingtools.com/overview-of-capital-budgeting
Re: Quantifying Risk
posted by Andrew , Mar 16, 2016, 5:28 PM
Risk involves financial variables susceptibility to negative changes from planned events. According to Zemke (2015) financial plans are based on consistencies of income and liabilities. After all, the essential business function to utilize either cash on hand, or borrow money to develop a product or service to gain a greater return. Risk associated with liabilities present themselves when a business is unable to pay its liabilities, cannot acquire financing, or exposure to unfavorable interest rates.

According to Boundless.com (2015) capital budget risk can be an operational risk, financial risk, or market risk and can entail corporate risk, international risk, industry risk, market risk, stand-alone risk, or project risk. Blackman (2014) notes that measuring and quantifying risk is accomplished by determining probability and impact of potential risk.

Blackman, A (2014). How to Measure Risk in Your Business. Retrieved from http://business.tutsplus.com/tutorials/how-to-measure-risk-in-your-business–cms-22763
Boundless.com. (2015). Risks Involved in Capital Budgeting. Retrieved from https://www.boundless.com/finance/textbooks/boundless-finance-textbook/the-role-of-risk-in-capital-budgeting-12/the-relationship-between-risk-and-capital-budgeting-96/risks-involved-in-capital-budgeting-421-7545/
Zemke, J. (2010). How to measure changes in the risk states – concept of definition. Journal of Applied Business Research, 26(5), 87-95. Retrieved from http://search.proquest.com/docview/750491980?accountid=35812
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