Uncertainty and risk in decision making

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Enterprise management, as well as, for example, state tasks of a socio-economic nature, can be carried out taking into account current uncertainties and risks. What are their specifics? How can they be calculated?

What is the essence of uncertainties and risks?

First of all, consider the concept of risk and uncertainty, how these terms can be interpreted in certain contexts.

Risk is commonly understood as the probability of an unfavorable or undesirable event occurring. For example, if we are talking about a business, this may be a change in market conditions so that the results of the economic activity of the enterprise will be far from optimal.

Uncertainty is understood as the inability to reliably predict the occurrence of an event, regardless of how desirable it may be. But, as a rule, uncertainty and risk are considered in the context of the onset of adverse conditions. The reverse situation - when it is impossible to predict the appearance of positive factors, is quite rarely perceived as uncertain,since in this case there is no need to determine the tactics of responding to the relevant factors. While in negative scenarios, such tactics are usually needed. This is due to the fact that in conditions of uncertainty and risk, the most important decisions can be made - economic, political. Let's explore how this can be done in more detail.

How to minimize uncertainty and risks?

The adoption of certain decisions in an environment characterized by uncertainty and risk is carried out using concepts that minimize the likelihood of errors or various undesirable scenarios. This approach can be effective in a variety of situations.

Uncertainty and risk are thus inherent in many spheres of life of a modern person. Approaches that are used in cases where it is necessary to minimize errors in certain actions can be based on:

- on identifying stable factors that can influence the situation;

- on the analysis of resources and tools available to the decision maker;

- on identifying temporary and unstable factors that can also influence the situation, but this is possible only under specific conditions (they also need to be identified).

Among those areas in which the relevant concepts are most in demand is management. There is a point of view that in the context of business management, uncertainty is a managerial risk,and one of the main ones. Here we find, therefore, another variant of the interpretation of the term in question. In the field of management, concepts that explore the essence of various risks are very common. Therefore, it will be useful first of all to study how uncertainty and risk are taken into account in the process of making managerial decisions in an enterprise.

Managing a business under uncertainty and risk

The following approach is common in business to overcome possible negative consequences when solving certain problems.

First of all, managers determine the list of objects whose behavior may be characterized by uncertainty and risks. This may be, for example, the market price of a sold product or service. In conditions of free pricing and high competition, it can be very problematic to unambiguously predict its course. The emergence of the risk of uncertainty in terms of the prospects for the receipt of revenue by the company is detected. Due to falling prices, its value may not be enough to pay off current liabilities or, for example, solve problems related to brand promotion.

In turn, an unexpectedly sharp increase in prices can lead to the accumulation of an excessive amount of retained earnings by the firm. Which, perhaps, in a different situation - with the systematic dynamics of revenue receipts - management would have invested in the modernization of fixed assets or the development of new markets.

Once an object characterized by uncertainty and risks in terms of business development has been identified,work is underway to determine the factors that affect the behavior of this object. These may be figures reflecting the market capacity and sales dynamics for enterprises that operate in a particular segment. It can be a study of macroeconomic, political factors.

The concept of risk and uncertainty, as we noted at the beginning of the article, can be associated with processes in various fields. Therefore, as a rule, the widest range of factors is taken into account here. For example, those related to the financial sector. We will study how the conditions of uncertainty and risk are examined in the course of decision-making on various monetary transactions.

Uncertainty and risk factors in the financial sector

We noted above that the managers of an enterprise, when developing an algorithm for making managerial decisions, first take into consideration an object that can be characterized by uncertainty and risks, and then they identify factors that determine the likelihood of conditions under which they can work.

The same can be done in the course of solving problems related to financial management. In the field of monetary transactions, the object that can be affected by uncertainty (risk is a special case of it) is most often the purchasing power of capital. Depending on certain conditions, it can increase or decrease. For example, due to inflation in the state economy, the exchange rate difference in the assessment of the national currency. which, in turn, candepend on macroeconomic, political processes.

Thus, in the field of decision-making related to money management, the levels of uncertainty (risk - as a particular, again, its case) can be represented at different levels.

Firstly, at the level of economic macro indicators (for example, GDP dynamics, trade balance, inflation), and secondly, in the field of individual financial indicators (as an option, the exchange rate of the national currency). Factors at both levels determine what the purchasing power of capital will be.

Having identified an object characterized by uncertainty and risks, as well as highlighting the factors influencing them, it is necessary to apply the methodology for the practical application of the decision. For example - developed by company managers or financial specialists. There are a large number of approaches for this. Among the most common is the use of a decision matrix. Let's study it in more detail.

Matrix as a tool for choosing decisions under risk and uncertainty

The technique in question is characterized primarily by its versatility. It is quite optimal for making decisions on objects that are characterized by economic risks and uncertainty, and therefore applicable in management.

The decision matrix involves the choice of one or more of them based on the highest probability of the chain of factors affecting the object. Thus, the main solution is chosen - calculated on one set of factors, and if they do not work (or, conversely, turn out to be relevant), thena different approach is chosen. Which involves the impact on the object of other factors.

If the second solution turns out to be not the most optimal, then the next one is applied, and so on, until it comes to choosing the least desirable approach, but giving the result. The formation of a list of solutions - from the most effective to the least effective, can be carried out using mathematical methods. For example, those involving building a graph of the distribution of the probability of triggering a particular factor.

Uncertainty and risk conditions can theoretically be calculated using methods of probability theory. Especially if the person who does this has at his disposal sufficiently representative statistical data. In the practice of economic and financial analysis, a large number of criteria have been formed, in accordance with which the probability of triggering certain factors of uncertainty and risks can be determined. It will be useful to study some of them in more detail.

Criteria for determining probability in uncertainty and risk analysis

Probability, as a mathematical category, is usually expressed as a percentage. As a rule, it is not a single value, but a combination of them - based on what conditions for triggering factors are formed. It turns out that several probabilities are taken into account, and their sum is 100%.

The main criterion for assessing the degree of probability of triggering certainfactors considered objectivity. It must be confirmed:

- proven mathematical methods;

- the results of statistical analysis of significant amounts of data.

Ideal - if both tools for identifying objectivity are used. But in practice, this situation rarely occurs. As a rule, economic risks and uncertainties are calculated with access to a relatively small amount of data. This is quite logical: if all enterprises had the same access to relevant information, then there would be no competition between them, and this would also affect the pace of economic development.

Therefore, when analyzing economic risks and uncertainty, enterprises most often have to focus on the mathematical aspect of calculating probability. The more perfect the appropriate methods of the firm, the more competitive the company will become in the market. Let's consider what methods can be used to determine the probability of formation of conditions for the operation of the factors of the behavior of objects, in relation to which a situation of uncertainty can be observed (risk - as a special case of it).

Methods for determining probability

Probability can be calculated:

- by analyzing typical situations (for example, when only 1 out of 2 events can occur with the highest probability, as an option: when tossing a coin, heads or tails fall out);

- through probability distribution (based on historical data orsample analysis);

- through expert scenario analysis - with the involvement of experienced professionals who are able to investigate the factors that affect the behavior of the object.

Having decided on the methods for calculating the probability in the framework of the calculation of uncertainty and risks, you can begin to practically determine it. Let's study how this problem can be solved.

How to determine the probability of an uncertain event in practice?

Practical determination of the probability of triggering a factor that affects an object, which is characterized by uncertainty and risks, begins with the formulation of specific expectations from the corresponding object. If this is the purchasing power of capital, then it can be expected to grow, stay the same, or decline.

The goals of the financier in this case can be, for example:

- investing capital with declining purchasing power in the modernization of fixed assets;

- formation on the basis of cash with a stable or growing purchasing power of additional volumes of retained earnings.

Suppose that the financier expects that capital - due to inflationary reasons - will nevertheless reduce its purchasing power, as a result of which it will need to be invested in the modernization of fixed assets. Thus, the risk (degree of uncertainty) in this case is that a significant amount of capital will be invested in a liquid asset, while its purchasing power may, contrary to expectations,grow up. As a result, the firm will receive less retained earnings. Its competitors, in turn, can use their capital more efficiently.

Having decided on the expectations regarding an object characterized by uncertainty and risks, it is necessary to study the totality of factors influencing the behavior of the corresponding object. These can be:

- economic indicators of the state (including inflation, the exchange rate of the national currency, which we have already mentioned above);

- the situation on the market of raw materials and funds demanded by the company (relative to the cost of which the purchasing power of corporate capital is calculated);

- dynamics of capital productivity (determining the prospects for the modernization of fixed assets of the company).

Further, using mathematical methods, the company calculates the greatest degree of impact on the object of certain factors, after which it determines the probability of each of them triggering.

Thus, it may turn out that the bulk of the company's capital is spent on the purchase of raw materials, materials and funds, while they are mainly imported from abroad. Consequently, the growth or decline in the purchasing power of the organization's funds will depend primarily on the dynamics of the national currency, and to a lesser extent on official inflation.

Sources of uncertainty (risks) in this case will be of a macroeconomic nature. So, the exchange rate of the national currency is influenced, first of all, by the balance of payments of the state,the ratio of assets and liabilities, the level of public debt, the total volume of transactions using foreign currency when settling with foreign suppliers.

Thus, the probability of an uncertain event - an increase, maintenance in a stable value or a decrease in the purchasing power of capital will be calculated by identifying the main factors affecting the relevant object, determining the conditions for triggering these factors, as well as the probability of their occurrence (which, in in turn, may depend on factors of a different level - in this case, macroeconomic).

Risk-Based Decision Making

So, we have studied how the probability of occurrence of conditions for the triggering of factors that affect the behavior of an object characterized by uncertainty and risks can be calculated. It will also be useful to study in more detail how decisions can be made in the face of uncertainty and risk.

Modern experts identify the following list of criteria that can be guided by in the framework of such tasks:

- probability of observing the expected indicators;

- prospects for achieving extremely low and high values for the indicators under consideration;

- the degree of dispersion between the expected, minimum and marginal indicators.

The first criterion involves choosing a solution, the implementation of which can lead to the achievement of an optimal result - for example, in the issue of investing capital in opening a factory forTV production in China.

Expected indicators in this case can be based on historical statistics or calculated (but based, again, on some practical experience of specialists who make the decision). For example, managers may have information that the profitability of TV production at a factory in China averages about 20%. Therefore, when they open their own factory, they can expect a similar return on investment.

In turn, they may be aware of cases in which certain firms did not reach these figures and, moreover, became unprofitable. In this regard, managers will have to consider such a scenario as zero or negative profitability.

However, financiers may have evidence that some firms have been able to achieve a 70% return on investment in Chinese factories. The achievement of the relevant indicator is also taken into account when making a decision.

The risk (the result of uncertainty in this case) when considering the possibility of investing in opening a factory in China may be the emergence of conditions for the operation of factors that negatively affect the object - the level of profitability. Those factors that can lead to the fact that the corresponding indicator will be negative. At the same time, another result of uncertainty may be the achievement of a profitability of 70%, that is, a figure that has already been achieved before by other businesses.

If the negative profitability wasshows, relatively speaking, 10% of factories opened in China, the figure of 70% will reach 5%, and the expected - of 20% - was recorded based on the results of the work of 85% of factories, then managers quite rightly can make a positive decision regarding investing in the opening of a factory for the production of televisions in China.

If negative profitability based on available data is recorded for 30% of factories, managers can:

- abandon the idea of investing in factories;

- to analyze the factors that may predetermine such a modest performance of investment in TV production.

In the second case, uncertainty and risk in management decisions will be considered based on new sets of criteria in terms of expecting optimal, maximum and minimum indicators. For example, the dynamics of purchase prices for components can be studied as one of the profitability factors. Or - indicators of demand in the market to which TVs manufactured at the factory in China are supplied.

CV

So, we have decided on the essence of such phenomena as uncertainty and risk in business. They can characterize a variety of objects. In the business sector, this is most often the purchasing power of capital, profitability, the cost of prices for certain assets.

Risk is most often considered by researchers as a special case of uncertainty. It reflects the probability of achieving an undesirable or negative result of anyactivities.

Risk and uncertainty are concepts that are closely related to the term "probability" related to mathematics. It corresponds to a set of methods that allow you to calculate whether the expectations of a manager, in the case of a business, or another stakeholder, are justified regarding factors that can affect uncertainty and risk in managing a business.