- Challenges associated with the capital planning process-
Capital planning includes
business strategy risk as well as management and corporate governance. It is
both science and arts at the same time. Simply put it is not mere mathematical exercise.
The process of capital planning must looks
into the future and to stresses that it did not previously contemplated both on
the business and on capital. Major elements involved in capital planning are
risk, capital and governance.
Risk – Identify the
assets material risk and measure the risk that is reliably identifiable.
Capital – Set
internal capital adequacy goals that relate direct to risk. This should me made
based on risk tolerance level of the entity. Assessment shall be made whether
risk is easily measurable or not.
Governance – It is
important to develop and maintain a framework which support different aspects
of capital planning.
Major challenges associated
with this process are-
ü Data challenges- Capital planning includes huge analysis of
data’s from financial market and from the inside source of the company. Hence,
it is very important that every data used in a capital planning process is
accurate for providing significant result. However, there are so many data is
used in this process, which is mere assumption, and challenges lies over there.
ü Governance challenges – Most of the time capital planning is
undergone under supervision of board. Key governance issues involved over here
is managing the whole procedures going through various phases.
ü MIS challenges- As it is discussed earlier that this
process requires huge amount data hence a sound management information system
is of the prime importance for a capital planning process.
ü Modeling challenges – The model are based mainly of two
functions explicit functions and implicit functions.
ü Assumptions and limitations- As it is stated earlier the process of
capital planning involved lots of assumptions and that is the reasons, which
create limitations of this procedures.
Risks involved in capital planning-
Capital planning involves risk management
decision making at the firm wide unit and line level. Capital planning is aligned with overall risk
management process and business risk measures. Budgeting for capital assets is
a tricky business that involves uncertain projections (and therefore a high
degree of risk), dependence on a range of expertise, linking long-term
projections with financial plans, and stringent record keeping and reporting. Various
type of risks involved in capital planning are-
o
Volatility
risks
o
Investment
risks
o
Market
risks
o
Corporate risk
o
International risk
o
Stand-alone risk
o
Competitive risk
o
Project specific risk
o
Industry specific risk
Techniques for minimizing the risks-
The process of minimizing risks starts with
identification of risks. It will also involve a comparison and analysis in
respect of risk tolerances across the organization. After these steps,
measurement of risks is carried out to judge materiality effect of risks. Financial
and business risk has two different type of risk reducing techniques. Following
are key risk assessment and reducing techniques used in capital planning-
o
Sensitivity
Analysis- This is “what if analysis” because of uncertainty of future.
o
Scenario
Analysis- Focus over here lies on deviation of number of in corrected
variables.
o
Break
Even Analysis- Provides a basis of judging minimum capital required and risk
can be tolerated.
o
Hillier
Model- analytical process of judging risks
o
Simulation
Analysis- Judge Risks based on random variables.
o
Decision
Tree Analysis - Assessment of alternative.
o
Corporate
Risk Analysis – Analyze risks entire cash flow of firm.
o
Risk Management
– Focus on various strategies.
o
Selection
of project under risk – Judgmental procedure
o
Practical
Risk Analysis- It’s a border concept, involves lots of analysis of implicit and
explicit data.
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