What does EBIT at Risk mean?
EBIT at Risk is a corporate Risk Management solution that shows the deviation between the actual EBIT and the planned value. In addition to that it can be used as a tool to measure and navigate the planned actions of the company. These actions can range from security measures to buy on the financial markets to strategic planning issues.
EBIT at Risk gives an intuitive automatic way to show the future results of the company and to model the entire complex range of interplay between risk factors, financial instruments and company planning. International companies face a myriad of risks. In today's competitive global market place and cut-throat competition tiny mistakes can be costly. Example: If airline company A buys jet fuel at the wrong time and a competitor B can buy at a lower price a swift change of ticket prices by B will hurt A immediately as the margins are so thin that A can not follow the price changes. For most commodity products customer loyalty is small.
A volatile Euro-USD currency exchange rate can cause major headaches to European exporters as they might get less money than planned for their products in North America. To make matters worse, North America is one of the biggest markets. Mistakes in the financial hedging strategy can be very costly as the automotive sector sadly demonstrated in the last years. This has motivated the search for better methodologies like EBIT at Risk and Cash Flow at Risk and tools.
In this example we focus on "financial" market risks like currency exchange or raw material prices, as we think these might be the easiest to implement and deliver instantaneous business value. We have also built EBIT / CFaR-models that consist of hard and soft factors. Soft factors can be the value of individual employees, IP law suits, the behavior of market competitors, etc..
EBIT at risk is an integrated Corporate Risk Management solution. The EBIT at Risk approach answers the question of how large the deviation between actual EBIT and the planned value (or that used in the budget) is due to changes in the underlying risk factors. One can define future revenue as: With a certain probability, depending on the risk appetite of the company, let's say 95, or 99%
total revenue = revenue already realized + 99% likely revenue to get + EBIT at Risk/Chance
EBIT at Risk: The amount you might still lose (with a given probability) An EBIT at Risk solution would allow to see:
- How are we standing? What size of fluctuations do we have to expect?
- What impacts do price changes in the underlying risk factors have?
- How are we secured against fluctuations? Did we cover enough of our exposure, while still being able to take advantage of our chances. It's a trade off between risk and chance.
- What options do we have? What financial instruments should we buy?
- What effect would a certain instrument have on our chance/risk profile?
- What effect does that instrument have for our EBIT at Risk?
- Additional classic and modern Risk performance measures like Cash Flow at Risk (CFaR)
- Possibility to steer with treasury and risk management to avoid unwanted surprises. For companies on the stock market, the end of business year result is especially crucial and should not be too volatile and most of all not let the expectations of the analysts down..
- Develop a benchmark and limit-system.
- Evaluate different strategies
- Liquidity planning
- Run the system "neutral" or with market opinions. See how it would effect your company and act upon.
Typical implementation steps
- Exposure mapping
We perform exposure mapping, where we look what impact changes in the underlying risk factors have.
Typically we focus on the changes in the cash flows as they are measurable. For a European based manufacturer we would for example look what effect a change on the currency markets have? We would work on the cash flows, either the daily or monthly planned ones or on aggregated ones, if the fine grained cash flows are not available. Typically treasury and controlling has this data.
One can start simple - let's assume we sell so many chips in North America in the next month. What would a fluctuation in exchange rate by n% imply? In a second step, one can go even further and include seasonality (if relevant) and changes in the number of chips sold due to price-changes, etc. Our experience is that a simple approach already offers a lot of insights and more complex models evolve with more experience and feel in the EBIT at Risk or Cash Flow at Risk Methodology.
- We put market models into place
Our models are not prognosis models, but allow to estimate the future range of values. In its simplest form one uses Monte Carlo simulations or a historical simulation. The different models combined form an integrated risk model, to take advantage of correlation effects (or more complex types of interdependence) and to avoid mistakes. Without this one might ignore existing natural synergies, or even make big mistakes.
- We analyze the existing data.
We require the current and the future (planned) cash flows. Typically one simulates from now till the end of the year or for the next one or two business years into the future.. Very often we need to interface with the Treasury systems to automatically get all cash flows, financial instruments, etc. into the system.
- With the cash flows and the model, we can say, what the likely range of results in the future will be.
- Then one takes financial instruments into account, like bonds, etc. that allows to modify this risk. Typically industrial companies for tax reasons limit the range of available instruments, but it is a very complex and difficult task to see where one is standing and in what direction one should be moving.
We make sure, that the client does not get a "black box" software, but fully understands the methodology and algorithms involved. In a first step we would work out the exposure map, chose the models and write a small, but concise "concept". In a second step we would implement the first risk factor and can already offer value for the customer. In a next step, we would extend the concept to include the second risk factor and add it to the model in the software tool and so o
You see where you are standing and how you can influence the result. Our solutions would make the everyday work of risk management, treasury and controlling much simpler and increase the value of the company, as through better insight and transparency the right decisions can be made. Costly mistakes or missed opportunities can be avoided by before simulating in which direction one has to go. The everyday job of treasury/controlling and risk management is already complex enough we want to simplify it by letting computers do the hard work they can do best: Looking at millions of scenarios. Humans only draw the conclusion from them.