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-
1. 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.
2. 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.
3. 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.
4. Modeling challenges- The model are based mainly of two functions explicit functions and implicit functions.
5. 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-
- Volatility risks
- Investment risks
- Market risks
- Corporate risk
- International risk
- Stand-alone risk
- Competitive risk
- Project specific risk
- 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-
a. Sensitivity Analysis- This is “what if analysis” because of uncertainty of future.
b. Scenario Analysis- Focus over here lies on deviation of number of in corrected variables.
c. Break Even Analysis- Provides a basis of judging minimum capital required and risk can be tolerated.
d. Hillier Model- analytical process of judging risks
e. Simulation Analysis- Judge Risks based on random variables.
f. Decision Tree Analysis - Assessment of alternative.
g. Corporate Risk Analysis – Analyze risks entire cash flow of firm.
h. Risk Management – Focus on various strategies.
i. Selection of project under risk – Judgmental procedure
j. Practical Risk Analysis- It’s a border concept, involves lots of analysis of implicit and explicit data.
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