Decision Making: Tools of the Trade,
Part 2

Our government and others have been working furiously to mitigate systemic risk, which is the risk of a total failure of a financial system. Risk may be a four-letter word, but it is not always bad. Every venture that has the possibility of reward also has risk. Risk is what companies measure, watch, and manage in order to maximize returns. Also, risk creates a barrier to entry for would be competitors. Risk management is vitally important when budgeting and forecasting.

Forecasting market risk or inherent risk is the first step in measuring and managing risk. Inherent risk is the probability of loss arising out of circumstances or existing in an environment. A baseline scenario for the forecast is generally developed to show the expected result over time assuming there is no change in how the company is operated, such as no addition to assets. This step generally includes assumptions about normal sales and expense growth. Next, create a second scenario adding general market variables. This scenario might show that demand is declining and sales are not growing as well as in the baseline scenario. Then develop a scenario where the market has stronger growth than the baseline.

Once inherent risk is assessed, other forms of risk can be evaluated by adding the expected effects of decisions on the multiple scenarios. For example, if a decision is made to finance the purchase of a large piece of equipment, the scenarios can measure the risk of not cash flowing enough with the purchase to cover the lease or loan payment. This is known as cash flow risk, the risk that a company's available cash will not be sufficient to meet its financial obligations. Cash flow risk is very important. Even if the long-term impact of a purchase decision is positive, not being able to make the payments in the near-term can have severe consequences for the business.

Forecasting the expected cash flows under multiple scenarios can help when securing financing for the equipment purchase. Not only can a lender better assess your business plan and possible success of the purchase, but your forecast can aid them in determining your plan's credit risk. The forecast will show that you’ve done your homework on the project and potentially increase your chances of obtaining financing. Business owners should consider the risk of obsolescence of a particular purchase, especially if the technology being purchased is in its first generation.

Incorporating risk into the budgeting and forecasting function is essential to the decision making process. The forecast can give a representation of risk assumptions based on what is known, and perhaps more importantly, not known. A business owner’s understanding of the risks involved in taking action can make the difference between success and failure.

Read “Assessing Financial Performance, Part 1.”

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—Jason A. Meyer is senior vice president, HPC Puckett & Company. Based in San Diego, Calif., HPC Puckett & Company specializes in mergers and acquisitions of wholesale optical laboratories. You can send comments or questions about this article or any other Dollars & Sense articles to Jason Meyer at [email protected].

Laura Bush of Encore Optics

Laura Bush has worked for Encore Optics in South Windsor, Conn., since it was founded in 2003. She started as the office manager and her responsibilities included day-to-day office duties, managing the machine interface system in DVI and assisting in processing drill rimless orders.

In 2008 Bush was promoted to operations manager. In addition to responsibilities she had previously, Bush now oversees all aspects of production. “I am responsible for the hiring and training of new employees, daily and weekly management meetings, new product integration and production flow,” she said.

Before beginning her optical career, Bush served in the Navy for four-and-a-half years where she built and maintained underwater mines. After leaving the Navy, in 1990 she was hired by Paul Zito as general office help at QSA Laboratory. Bush's dedication and drive helped her advance to inventory manager and then to office manager. She continued in this role even after the laboratory was acquired by Hoya in 2000.

Bush and Zito left Hoya in 2003 to start Encore Labs. “Our management staff has worked together as a team for over 20 years,” she said. “We know how to work together to achieve our goal of having a productive and motivated atmosphere. Even with our busy days, the environment is upbeat and easy going.”

Adding to the upbeat atmosphere are the amusing comments Bush receives when she introduces herself, given the coincidence of her name being the same as the former first lady's. “When I call someone or meet someone for the first time and identify myself, there is always a pause and usually a giggle. I typically will joke to put them at ease. It was fun recently to be able to comment about how 'I would be done soon' or 'I couldn't wait to be home',” she said.

Bush says the highlight of her career came when she was promoted to operations manager. “We are always looking for ways to improve and I love the challenge. I will continue to grow with Encore. In five short years, Encore has grown to be the size that took QSA 15 years. I cannot wait to see what the next five years bring,” she said.—Samantha Toth

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