Financial Risks in Construction

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Financial Risks in Construction

Discuss financial risks in construction, highlighting historical background, current issues/practices and implications/relevance to construction project management generally and specifically to construction project planning and control, feasibility study and appraisal, and financing. 1.0 Definitions i. The Project Management Institute‟s (PMI) A Guide to the Project Management Body of Knowledge (PMI 2008) defines project risk as: An uncertain event or condition that, if it occurs, has a positive or a negative effect on at least one project objective. ii. iii. According to the Oxford English Dictionary (2009), risk is a situation involving exposure to danger or the possibility that something unpleasant will happen. The ISO 31000 (2009) /ISO Guide 73:2002 definition of risk is the 'effect of uncertainty on objectives'. In this definition, uncertainties include events (which may or not happen) and uncertainties caused by ambiguity or a lack of information. It also includes both negative and positive impacts on objectives; this definition was developed by an international committee representing over 30 countries and is based on the input of several thousand subject matter experts. The British Standard on Project Management (EN BS 6079-3:2000) defines Risk as an uncertainty inherent in plans and the possibility of something happening (i.e. a contingency) that can affect the prospect of achieving business or project goals.

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2.0 Risks 2.1 Financial risk Financial risk is an umbrella term for multiple types of risk associated with financing, including financial transactions that include company loans in risk of default. Risk is a term often used to imply downside risk, meaning the uncertainty of a return and the potential for financial loss. Financial risk include, i. ii. iii. iv. v. Inflation. Availability and fluctuation in foreign exchange. Delay in Payment. Repatriation of funds. Local taxes

2.2 Construction Financial Risk According to the above definitions therefore, financial construction risk are financial risks that are associated with the construction industry. Financial construction risks may include: Profitability, Value of contract (size), balance sheet debt, Off-balance sheet debt, Level of exposure, foreign currency exposure, Terms of payment, operator creditworthiness, Insurance among many other risks.

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Financial Risks in Construction

3.0 History of Risk Management The word risk has its roots in the old French word risqué, which means “danger, in which there is an element of chance” (Littré, 1863). The word hazard, another term integral to discussions of risk management, comes from a game of chance invented at a castle named Hasart, in Palestine, while it was under siege (Oxford English Dictionary, 1989). Risk management has been practiced for thousands of years. Very early on, lenders learned to reduce the risk of loan defaults by limiting the amount loaned to any one individual and by restricting loans to those considered most likely to repay them. Money and financial interests drove early thinking on the topic of risk. Aristotle, in his treatise Politics, discusses the concept of options – a financial instrument that allows individuals to buy and sell goods from one another at pre-arranged prices. Initially, the risk management process focused on what has been termed “pure risks.” Pure risks are those in which there is either a loss or no loss. Either something bad happens, or it doesn‟t. Beginning in the 1970s, financial risk became an important source of uncertainty for firms and, shortly thereafter, tools for handling financial risk were developed. These new tools allowed financial risks to be managed in a similar fashion to the ways that pure risks had been managed for decades. Volatility in foreign exchange rates, prices and interest rates caused financial risk to become an important concern for institutions including the construction industry. 4.0...
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