Report in Engineering

Management
MANAGING PRODUCTION AND SERVICE
OPERATIONS & MANAGING THE
FINANCE FUNCTION

PREPARED BY:

Raon, Ejay L.
Raotraot, Allen Marie P.
Siapno, Mark Christian
Tabuena, Melchezidek Z.
Tarim, Alvin C.

ENGR. DARWIN MURILLO

Professor

FEBRUARY 25, 2017

 MANAGING PRODUCTION AND SERVICE OPERATIONS

Organizations are designed mainly to produce products or services. If these

organizations must survive and grow, the operations function must be undertaken in the
most economical manner possible.

WHAT OPERATION IS

Operation refers to "any process that accepts inputs and uses resources to
change those inputs in useful ways"

Examples of finals goods and services are as follows:

1. Industrial chemicals like methylene chloride, borax powder, phosphoric acid,

etc. Which are produced by chemical manufacturing firms;

2. Services like those for the construction of ports, high rise buildings, roads,
bridges, etc, which are produced by constructions firms;

3. Electrical products like transformers, circuit breakers, switch gears, power

capacitors, etc. Which are produced by electrical manufacturing firms;

4. Electronic products like oscilloscope, microwave, which are produce by

electronic firms;

5. Mechanical devices like forklifts, trucks, loaders etc. Which are produced by
manufacturing firms;

6. Engineering consultancy services like those for construction management and

supervision, project management services, etc., which are produced by engineering
consultancy firms.
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PRODUCTION PROCESS

OPERATION MANAGEMENT

Operations are an activity that needs to be managed by competent persons. It is

the process of planning, organizing and controlling operations to teach objectives
efficiently and effectively.

OPERATIONS AND THE ENGINEER MANAGER

The engineer manager is expected to produce some output at whatever

management level he is. If he is assigned as the manufacturing engineer, his function is
to determine and define the equipment, tools and processes required to convert the
design of the desired product into reality in an efficient manner.

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Organization Chart of a Manufacturing Firm

Organizational Chart of a Construction Firm

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TYPES OF TRANSFORMATION PROCESSES

The engineer manager must have some knowledge of the various types of
transformation process. They are as follows:

1. Manufacturing processes

a.) job shop

b.) batch flow

c.) worker-paced line flow

d.) machined-paced line flow

e.) continuous flow

f.) batch/continuous flow hybrid

2. Service processes

a.) service factory

b.) service shop

c.) mass service

d.) professional service

Manufacturing Processes

Processes that refer to the making of products by hand or with machinery.

a.) Job Shop

Production is based on sales orders for a variety of small lots.

custom products in general

products may be manufactured within short notice

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equipment used are of general purpose type

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Preparation and
Lathe Inspection
Grouping of Milling Grinding
Work and Shipping
Materials

Figure 10.4 Process Flow Diagram for a Job Shop

b.) Batch Flow

Batch flow process is where lots of generally own designed products are
manufactured.

characterized by the following:

1. There is flexibility to produce either low or high volumes.

2. Not all procedures are performed on all products.

3. The types of equipment used are mostly for general purpose.

Examples of factories using large batch flow are wineries, scrap-metal reduction
plants and road-repair contractors.

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 C.) Work-Paced Assembly Line

Refers to a production layout arranged in a sequence to accommodate

processing of large volumes of standardized products or services.

The quality and quantity depends to a great extent to the skill of the labor
utilized.

Examples are food marts like McDonalds and Shakeys.

Characterized by the following:

1. The products manufactured are mostly standardized.

2. There is a clear process pattern.

3. Specialized equipment is used.

4. The size of operation is variable.

5. The type of layout used is the line flow.

6. Labor is still a big cost item.

Figure 10.6 Assembly Line for Production or Service

Station 1 Station 2 Station 3 Station 4 Finished

Raw Materials Materials Materials Materials Materials Item or
(for customer) and/or and/or and/or and/or Complete
Labor Labor Labor Labor Service

d.) Machined-Paced Assembly Line

This type of production process produces mostly standard products with

machines playing a significant role.

Among its other features are as follows:

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1. The process is of clear rigid pattern.

 2. Specialized type of equipment is used.

3. The line flow layout is used.

4. Capital equipment is a bigger cost item than labor.

5. Operation is large.

6. The process is machine-paced.

Examples of machine-paced assembly are automobile manufacturers like

General Motors and Ford Motors.

Figure 10.7 A Machined-Paced Assembly Line Process: Automobile Manufacturing

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e.) Continuous Flow

Characterized by the rapid rate at which items move through the

system.

Very appropriate for producing highly standardized products like

calculators, typewriters, automobiles, televisions, cellular phone, etc.

Its other characteristics are as follows:

1. There is economy of scale in production, resulting to low per unit cost

of production.

2. The process is clear and very rigid.

3. Specialized equipment is used.

4. The line flow layout is used.

5. Operation are highly capital intensive.

6. The size of operation is very large.

7. Processing is fast.

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f.) Batch/Continuous Flow Hybrid

This method of processing is a combination of batch and the continuous

flow.

Two distinct layouts are used, one for batch and one for continuous flow.

Typical size of operation is also very large giving opportunities for

economies of scale.

Examples of companies using this processing are breweries, gelatin

producers and tobacco manufacturers.

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Service Processes

Service processes are those refer to the provision of service to persons by hand
or with machinery.

a.) Service Factory

Offers a limited mix of services which results to some economies of scale

in operations.

Also affords the company to complete in terms of price and speed of

producing the service.

The process layout preferred is the rigid pattern of line flow processing.

McDonalds and Shakeys are also example of service factories.

b.) Service Shop

Provides a diverse mix of services.

The layouts used are those for job shops or fixed position and are
adaptable to various requirements.

Examples are Servitek and Megashell. Among the services provided by

these shops are car tune-up, wheel balancing, wheel alignment, change
oil, etc.

c.) Mass Service

A mass service company provides services to a large number of people

simultaneously.

To be able to serve many people, mass service companies offer limited

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mix of services.
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 The process layout used is typically fixed position where costumers move
through the layout.

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d.) Professional Services

Professional service firms offer a diverse mix of services.

There is a lower utilization of capital equipment compared to the service

factory and service shop.

The service pattern use is very loose.

The process layout used is identical to the job shop.

Example of firms which provide specialized services to other firms or

individuals are as follows:

1. Engineering or management consulting services which help in the

plant layout or the efficiency of a company.

2. Design services which supply designs for a physical plant,

products and production materials.

3. Advertising agencies which help promote a firms products.

4. Accounting services.

5. Legal services.

6. Data processing services.

7. Health services.

Professional service firms are, oftentimes, faced with delivery problems

brought about by non-uniform demand.

Strategies that may be used depending on the situation are as follows:

1. The use of staggered work-shift schedules.

2. The hiring of part-time staff.

3. Providing the customer with opportunity to select the level of service.

4. Installing auxiliary capacity or hiring subcontractors.

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5. Using multi-skilled floating staff.

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 6. Installing customers self-service.

IMPORTANT PARTS OF PRODUCTIVE SYSTEMS

Productive systems consist of six important activities as follows:

1. Product Design
2. Production Planning and Scheduling
3. Purchasing and Materials Management
4. Inventory Control
5. Work Flow Layout
6. Quality Control

Product Design

Customers expect that the products they buy would perform according to
assigned functions. A good product design assures that this will be so. Customers avoid
buying products with poor product design. An example is that certain brand of ballpen
which fails to write after one or two days of actual use. This happens because of poor
product design.

Product design refers to the process of creating a set of product specifications

appropriate to the demands of the situation.

Companies wanting to maintain or improve its market share keep a product

design team composed engineers, manufacturing, and marketing specialists.

Production Planning and Scheduling

Production planning may be defined as forecasting the future sales of a given

product, translating this forecast into the demand it generates for various production
facilities, and arranging for the procurement of these facilities.
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 Production planning is a very important activity because it helps management to
make decisions regarding capacity. When the right decisions are made, there will be
less opportunities for wastages.

Scheduling is the phase of production control involved in developing timetables

that specify how long each operation in the production process takes. Efficient
scheduling assures the optimization of the use of human and nonhuman resources.

Purchasing and Materials Management

Firms need to purchase supplies and materials required in the various production
activities. The management of purchasing and materials must be undertaken with a high
degree of efficiency and effectiveness especially in firms engaged in high volume
production. The wider variety of supplies and materials needed add to the necessity of
proper managing and purchasing of materials.

Materials management refers to the approach that seeks efficiency of operation

through integration of all material acquisition, movement, and storage activities in the
firm.

Inventory Control

Inventory control is the process of establishing and maintaining appropriate

levels of reserve stocks of goods. As supplies and materials are required by firms in the
production process, these must be kept available when they are needed. Too much
reserve of stocks will penalize the firm in terms of high storage costs and other related
risks like obsolescence and theft. Too little reserves, on the other hand, may mean lost
income opportunities if production activities are hampered. A balance between the two
extremes must be determined.

There are ways of achieving proper inventory control. They are as follows:

1. Determining reorder point and reorder quantity

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2. Determining economic order quantity

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3. The use of just-in-time (JIT) method of inventory control

 4. The use of the material requirement planning (MRP) method of planning and
controlling inventories.

Work-Flow Layout

Work-flow layout is the process of determining the physical arrangement of the

production system. In the transformation process, the flow of work may be done either
haphazardly or orderly.

The job of the operations manager is to assure that a cost-effective work-flow

layout is installed. A good work-flow layout will have the following benefits:

1. Minimize investment in equipment.

2. Minimize overall production time.
3. Use existing space most effectively.
4. Provide for employee convenience, safety, and comfort.
5. Maintain flexibility of arrangement and operation.
6. Minimize material handling cost.
7. Minimize variation in type of material-handling equipment.
8. Facilitate the manufacturing (or service) process.
9. Facilitate the organizational structure.

Quality Control

Quality control refers to the measurement of products or services against

standards set by the company. Certain standard requirements are maintained by the
management to facilitate production and to keep customers satisfied.

Poor quality control breeds customer complaints, returned merchandise,

expensive lawsuit, and huge promotional expenditures.
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 MANAGING THE FINANCE FUNCTION

Engineering firms need funds to finance their operations. To be assured of continuous

supply of funds, there is a need to manage properly the finance function. When funds
are made available in right amounts at the right time, the engineering organization may
be expected to function properly. When funds are not enough to finance planned
activities, the risk of failure to achieve objectives becomes apparent.

The engineer manager must understand that the finance function is a very
important management concern. This is true because without adequate funds it will be
difficult, if not impossible to proceed with the production of products or services, the
distribution of output, research and development, and others.

WHAT THE FINANCE FUNCTION IS

The finance function is an important management responsibility that deals with

the procurement and administration of funds with the view of achieving the objectives of
business. If the engineer manager is running the firm as a whole, he must be concerned
with the determination of the amount of funds required, when they are needed, how to
procure them, and how to effectively and efficiently use them.

In the performance of his duties, the engineer manager, at whatever

management level he is, must do his share in the achievement of the financial objectives
of the company.

The finance function is one of the three basic management functions. The other
two are production and marketing. 16
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Figure 12.1: The Finance Function: A Process Flow

Determination
of fund 1. Short-term
requirements 2. Long-term

Procurement
of funds 1. Short-term
2. Long-term

Effective and
efficient use 1. Short-term
of funds
2. Long-term

THE DETERMINATION OF FUND REQUIREMENTS

Any organization, including the engineering firm, will need funds for the following
specific requirements:

1. To finance daily operations

2. To finance the firms credit services
3. To finance the purchase of inventory
4. To finance the purchase of major assets

Financing Daily Operations

The day-to-day operations of the engineering firm will require funds to take care
of expenses as they come. Money must be made available for the payment of the
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following:
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1. Wages and salaries

 2. Rent
3. Taxes
4. Power and light
5. Marketing expenses like those for advertising, entertainment, travel expenses,
telephone and telegraph stationery and printing, postage, etc.
6. Administrative expenses like those for auditing, legal, services, etc.

Any delay in the settlement of the foregoing expenses may disrupt the effective
flow of work in the company. It may also erode the publics confidence in the ability of
the company to operate on a long-term basis. Creditors, for instance, may withhold the
extension of credit to the company.

Financing the Firms Credit Services

It is oftentimes unavoidable for firms to extend credit to customers. If the

engineering firm manufactures products, sales terms vary from cash to 90-day credit
extensions to customers. Construction firms will have to finance the construction of
government projects that will be paid many months later.

When a new chemical manufacturing firm finds difficulty in convincing distributors

to carry their products, a credit extension may solve the problem. A new problem,
however, will be created, i.e., how the credit arrangement will be financed.

Financing the Purchase of Inventory

The maintenance of adequate inventory is crucial to many firms. Raw materials,

supplies, and parts are needed to be kept in storage so they will be available when
needed. Many firms cannot cope with delays in the availability of the required material
inputs in the production process, so these must be kept ready whenever required.

The purchase of adequate inventory, however, will require sufficient funding and
this must be secured.
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Sometimes, inventories unnecessarily tie-up large amount of funds. The engineer

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manager must devise some means to make sure this situation does not happen.
Financing the Purchase of Major Asset

Companies, at times, need to purchase major assets. When top management

decides on expansion, there will be a need to make investments in capital assets like
land, plant, and equipment.

It is obvious that the financing of the purchase of major assets must come from
long-term sources.

The Sources of Funds

To finance its various activites, the engineering firm will have to make use of its
cash inflows coming from various sources, namely:

1. Cash sales. Cash is derived when the firm sells its products or services.
2. Collection of Accounts Receivables. Some engineering firms extend credit to
customers. When these are settled, cash is made available.
3. Loans and Credits. When the other sources of financing are not enough, the firm
will have to resort to borrowing.
4. Sales of Assets. Cash is sometimes obtained from the sale of the company's
assets.
5. Ownership Contribution. When cash is not enough, the firm may tap its owners to
provide more money.
6. Advances from customers. Sometimes, customers are required to pay cash
advances on orders made. this helps the firm in financing its production activities.

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Long-Term Assets LONG-TERM FINANCING
Production
Long-term debt
Equipment
Common Stock
Land
Retained earnings
Buildings

ACCOUNT
RECEIVABLES

Marketable
Securities

Short-Term Fund Sources

Commercial Banks
Supplies Commercial paper houses
Materials Finance Companies
Factors
Taxes Insurance Companies
Salaries
Wages
Rent
Insurance

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Short-Term Sources of Funds
Loans and credits may be classified as short-term, medium-term, or long-term.
Short-term sources of funds are those with repayment schedules of less than one
year. Collaterals are sometimes required by short-term creditors.

Advantages of Short-Term Credits. When the engineering firm avails of short-term

credits, the following advantages may be derived:

1. They are easier to obtain. Creditors maintain the view that the risk involved in
short-term lending is also short-term. Thus, short-term credits are made easily
available to qualified borrowers.
2. Short-Term financing is often less costly. Since short-term financing is favored by
creditors, they make it available at less cost.
7. 3.Short-term financing offers flexibility to the borrower. After the borrower has
settled his short-term debt, he may consider other means of financing. if he still
requires it. Long-term financing, in contrast, eliminates this option. He is stuck
with the long-term funds even if he no longer requires it.

Disadvantages of Short-Term Credits. Short-term financing has also some

disadvantages. They are as follows:

1. Short-term credits mature more frequently. This may place the engineering firm
in a tight position more often than necessary. When the frequency of the firm's
cash inflows are more than twelve months apart, the firm could be in serious
trouble meeting its short term obligations.

2. Short-term debts may, at times, be more costly than long-term debts. When
short-term debts are used to finance long-term expenditures, the frequent
renewals, adjustment of terms, and shopping for new sources may prove to be
more costly.

Supplies of Short-Term Funds. Short-term financing is provided by the following:

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1. Trade creditors
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2. Commercial Banks
3. Commercial paper houses
4. finance companies
5. factors, and
6. Insurance companies

Trade creditors refer to suppliers extending credit to a buyer for use in

manufacturing, processing, or reselling goods for profit. The instruments used in trade
credit consist of the following:(1) open-book credit, (2) trade acceptance, and (3)
promissory notes.

The open-book credit is unsecured and permits the customer to pay for goods
delivered to him in a specified number of days. For financially week engineering firms,
the open-book credit is a very useful source of financing.

The trade acceptance is a time draft drawn by a seller upon a purchase payable
to the seller as payee, and accepted by the purchaser as evidence that the goods
shipped are satisfactory and that the price is due and payable. Under the terms granted
in the trade acceptance, the seller allows the buyer to pay within a certain number of
days. The arrangement provides the buyer some relief in financing his short-term
requirements.

A promissory note is an unconditional promise in writing made by one person to

another, signed by the maker, engaging to pay, on demand or at a fixed or determinable
future time, a certain sum of money to, or to the order of, a specified person or to bearer.

Commercial banks are institutions which individuals or firms may tap as source of
short-term financing. Commercial banks grant two types of short-term loans:(1) those
which require collateral, and (2) those which do not require collateral. Examples of
commercial banks granting short term loans are City Trust, Premier Bank, and Land
Bank.

Commercial paper houses are those that help business firm sin borrowing funds
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from the money market. Under this scheme, the business firm in need of funds issues a
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commercial paper, which is a short-term promissory note, generally unsecured, and

issued by large, established firms. The commercial paper is sold to investors through the
commercial paper house.

Business finance companies are financial institutions that finance inventory and
equipment of almost all types of sizes of business firms. Examples of finance companies
in the Philippines are Philacor Credit Corporation and Consolidated Orix Leasing and
Finance Corporation.

Factors are institutions that buy the accounts receivables of firms, assuming
complete accounting and collection responsibilities. Engineering firms which maintain
sizable amounts of accounts receivable may avail of the services of factors when they
are in dire need of cash.

Insurance Companies are also possible sources of short-term funds. Industry

reports indicate that insurance companies in the Philippines regularly make investments
in short-term commercial papers and promissory notes.

Long-Term Sources of Funds

There are instances when the engineering firm will have to tap instances when
the engineering firm will have to tap the long-term sources of funds. An example is when
expenditures of capital assets become necessary. After the mount required is
determined, a decision has to be made on the type of source to be used.

Long-term sources of funds are classified as follows:

1. Long-term debts
2. Common stocks, and
3. Retained earnings.

Long term debts are sub-classified into term loans and bonds.

Term Loans. A term loan is a "commercial or industrial loan from a commercial

bank, commonly used for plant and equipment, working capital, or debt repayment."
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Term loans have maturities of 2 to 30 years."

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The advantages of term loans as a long-term source of funds are as follows:

1. Funds can be generated more quickly than other long-term sources.

2. They are flexible, i.e., they can be easily tailored to the needs of the borrower.
3. The cost of issuance is low compared to other long-term sources.

Bonds. A bond is a certificate of indebtedness issued by a corporation to a lender. It

is a marketable security that the firm sells to raise funds. Since the ownership of bonds
can be transferred to another person, investors are attracted to buy them.

The type of bonds are show in figure12.3.

Common Stocks. The third source of long-term funds consists of the issuance of
common stocks. Since common stocks represent ownership of corporations, many
investors are placing their money in them. When properly utilized, common stocks can
be cheaper and more stable sources of long-term funds. Unlike bonds and term loans
which must be repaid at a certain date, common stocks do not have maturity and
repayment dates.

Retained Earnings. Retained earnings refer to "corporate earnings not paid out
as dividends." this simply means that whatever earnings that are due to the stockholders
of a corporation are reinvested. Because these retained earnings can be used by the
firm indefinitely, they become an important source of long-term financing

Figure 12.3 Types of Bonds

TYPE OF BOND FEATURE
1. Debentures No collateral requirement
2. Mortgage bond Secured by real estate
3. Collateral trust bond Secured by stocks and bonds owned by
the issuing corporation
4. Guaranteed bond Payment of interest or principal is
guaranteed by one or more individuals or
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corporations
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 5. Subordinated debentures With an inferior claim over other debts

6. Convertible bonds Convertible into shares of common stock

7. Bonds with warrants Warrant are options which permit the
holder to buy stock of the issuing
company at a stated price
8. Income bonds Pays interest only when earned

In like manner, the sole owner of an engineering firm may decide to reinvest
whatever profits he derives from his business. The same decision may be adapted by
the owners of a partnership.

THE BEST SOURCE OF FINANCING

As there are various fund sources, the engineer manager, or whoever is in
charge, must determine which source is the best available for the firm.

To determine the best source, Schall and Haley recommend that the following
factors must be considered.

1. Flexibility
2. Risk
3. Income
4. Control
5. Timing
6. Other factors like collateral values, flotation costs, speed and exposure

Flexibility
Some fund sources impose certain restrictions on the activities of the borrows.
An example of a restriction is the prohibition on the issuance of additional debt
instruments by the borrower.
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As some fund sources are less restrictive, the flexibility factor must be
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considered. In General, however, short-term funds sources offer more flexibility than
long-term sources. This is so because after settling the debt, short-term borrowers may
shift to other types of financing. Long-term borrowers are given this opportunity only after
a long period of waiting.

Risk
When applied to the determination of fund sources, risk refers to the chance that
the company will be affected adversely when a particular source of financing is chosen.

Generally, short-term debt subjects the borrowing firm to more risk than does
financing with long-term debt. This happens because of two reasons:
1. Short-term debts may not be renewed with the same terms as the previous one,
if they can be renewed at all.
2. Since repayments are done more often, the risk of defaulting is greater.

Income
The various sources of funds, when availed of, will have their own individual
effects in the net income of the engineering firm. When the firm borrows, it must
generate enough income to cover the cost of borrowing and still be left with the sufficient
returns to the owners.

It is possible that the owners were enjoying higher rates of return on their
investments before borrowing was made. The reverse may happen, however, at other
times. Nevertheless, the effects on income must be considered in determining the
source of funding to be used.

Control
When new owners are taken in because of the need for additional capital, the
current group of owners may lose control of the firm. If the current owners do not want
this to happen, they must consider other means of financing.

Timing
The financial market has its ups and downs. This means that there are times
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when certain means of financing provide better benefits than at other times. The
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engineer manager must, therefore, choose the best time for borrowing or selling equity.
Other Factors
There are other factors considered in determining the best source of funds. They
are as follows:

1. Collateral values: are there assets available as collateral?

2. Flotation cost: how much will it cost to issue bonds or stocks?
3. Speed: how fast can the funds required be raised?
4. Exposure: to what extent will the firm be exposed to other parties?

THE FIRMS FINANCIAL HEALTH

In general, the objectives of engineering firms are as follows;
1. In make profits for the owners.
2. To satisfy creditors with the repayment of loans plus interest.
3. To maintain the viability of the firm so that customers will be assured of a
continuous supply of products or services, employees will be assured of a
market, etc.
The foregoing objectives have been better chances of achievement. If the
engineering firm is financially healthy and has the capacity to be so on a long-term basis.

INDICATORS OF FINANCIAL HEALTH

The financial health of an engineering firm may be determined with the use of
three basic financial statements. These are as follows;
1. Balance sheet also called statement of financial position.
2. Income statement also called statement of operation.
3. Statement of changes in financial position.
To be able to determine the financial health of a firm, the appropriate financial
analysis must be undertaken.

RISK MANAGEMENT AND INSURANCE

The engineer manager, especially those at the top level, is entrusted with the
function of making profits for the company. This will happen if losses brought by
improper management of risks are avoided.
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Risk is a very important concept that the engineer manager must be familiar with.
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Risks confront people everyday. Companies are exposed to them. Newspapers report
on a daily basis the destruction of life and property. Companies that could not cope with
losses are forced to shut down, according to report.
Fortunately the engineer manager is not entirely helpless. He can use sound risk
management practice to avoid the threat of bankruptcy due to losses.

Risk Defined
Risk refers to the uncertainty concerning loss or injury. The engineering firm is
faced with a long list of exposure to risks, some of which are as follows:
1. Fire
2. Theft
3. Floods
4. Accidents
5. Nonpayment of bills by customers (bad debts)
6. Disability and death
7. Damage claim from other parties

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Type of Risk
Risk may be classified as either pure or speculative. Pure risk is one in which
there is only a chances of loss . This means that there is no way of making gains with
pure risks. An example of pure risk is the exposure to loss of the companys motor car
due to theft. Pure risks are insurable and may be covered by insurance.
Speculative risk is one in which there is a chance of either loss or gain. This type
of risk is not insurable. An example is an investment is common stocks. If one wants to
make gains in the common stock market, the nuances and intricacies of investments
must be learned and properly applied.

What is Risk Management

Risk management is an organized strategy for protecting and concerning assets
and people. The purpose of risk management is to choose intelligently from among all
the available methods of dealing with risk in order to secure the economic survival of the
firm.
Risk management is designed to deal with pure risks, while the application of
sound management practice is directed towards speculative risk that are inherent and
cannot be avoided.

Methods of Dealing with Risk

There are various methods of dealing with risks. They are as follows;
1. The risk may be avoided
2. The risk may be retained
3. The hazard may be reduced
4. The losses may be reduced
5. The risk may be shifted

A person who wants to avoid the risk of losing a property like a house can do so
by simply avoiding the ownership of one.
Risk retention is a method of handling risk wherein the management assumes
the risk. Planned risk retention, also called self-insurance, is a conscious and deliberate
assumption of a recognized risk. Unplanned risk retention exists when management
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does not recognize that a risk exists and unwisely believes that no loss could occur.
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 Hazards may be reduced by simply instituting appropriate measures in a variety
of business activities.
When losses occur in spite of preventive measures, the severity of loss may be
limited by way of reducing the concentration of exposures. Examples of efforts on loss
reduction are as follows:
1. Physically separating buildings to minimize losses in case of fire
2. Using fireproof materials on interior building construction
3. Storing inventory in several locations to minimize losses in case of fire and theft
4. Maintain duplicate records to reduce accounts receivable losses
5. Transporting goods in separate vehicles instead of concentrating high values in
single shipments
6. Prohibiting key employees from traveling together
7. Limiting legal liability by forming several separate corporations

Another method of handling risk is by shifting it to another party. Examples of risk

shifting are hedging, subcontracting, incorporation and insurance.
Hedging refers to making commitments on both sides of a transaction so the
risks offset each other.
When a contractor is confronted with a contract bigger than his companys
capabilities, he may invite subcontractors in so that some of the risks may be shifted to
them.
In a corporation, a stockholder is able to make profits out of his investments but
without individual responsibility for whatever errors in decisions are made by the
management. The liability of the stockholders is limited to his capital contribution.
To shift risk to another party, a company buys insurance. When a loss occurs,
the company is reimbursed by the insurer for the loss incurred subject to the term of the
insurance policy.
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