Managing Business Risks: Warning Signals that Help Avert Business Failure

Man’s survival since the beginning of time has relied on his ability to see signs of threats before they happen. This enabled him to prepare for the perceived threat and thus mitigated the adverse effects of the event--- when it happens---to his habitat and to his fellow human beings.

The ability to identify early warning signals (EWS) and to effectively act on them has become essential to man’s survival and is now a vital component of many aspects of his life.

From the environment, to man-made structures and from military and political organizations to business enterprises, early warning systems are found and make our world a more stable and safer place to live in.

What is an Early Warning System?

A more fundamental understanding of early warning systems may be gleaned from the following definition: “It is the process of gathering, sharing, and analyzing information to identify a threat or hazard sufficiently in advance for preventive action to be initiated.”

An early warning signal management system (EWSMS) therefore is a network of actors, practices, resources and technologies that has their common goal of detecting and warning about an imminent threat so preventive measures can be taken to control the threat or mitigate its harmful effects. The underlying assumption is that threats develop over incubation periods during which warning signals may be discerned, tracked and assessed.

Because many threats can have far-reaching and devastating impact, early warning systems today tend to be distributed, multi-level, and collaborative, and may be implemented or supported by a coordinating body or central clearinghouse.

Examples of these EWSs are the tsunami warning system in place in the Indian Ocean, the J-Alert system, a satellite based nationwide warning system in Japan to inform the public of threats, the typhoon warning system of the PAG-ASA, and the most common Warning Signal of an oncoming train in railroad crossings.

Then there are more primitive and natural warning signals such as the use of birds (canary) in detecting toxic gases in mines. When the bird dies inside the mines then its air quality is unsafe. Then there are the instinctive warning signals in our bodies such as fear and pain. The former is man’s emotional response to danger; the latter is part of the body’s defense system to avoid a harmful situation in the future.

In finance, more specifically in credit and loans management, early warning systems have increasingly been used by banks and other lenders to manage their portfolio and lessen the risk of loan default and consequently of portfolio quality deterioration. And since recent episodes of financial crises, early warning systems have been part of risk management structures in financial institutions.

The same basic principles can be applied in the management of enterprises, and EWS is a useful tool in being able to anticipate the occurrence of threats and thereby mitigate the adverse effects of a disaster when it comes.

How and where do we generate EWSs?

Early warning signals can be found in the most unsuspected places and circumstances.

In fact it can be found in our day to day work of going about our business. But that would be passive action and reactive response to possible threats if we waited for warnings to pop up our noses, and we do not want that kind of situation in dealing with uncertainty. We want to be capable of generating EWSs and be able to deal with them proactively.

We are able to generate EWSs from the data and information gathered in the course of monitoring our enterprise’s financial performance and operations and that of our suppliers, buyers, and markets. In short, the mechanism to generate EWSs lie in the Monitoring System in place in the different aspects of our enterprise’s operations and activities and that of the environment in which it operates such as the social, political, and economic conditions prevailing in the areas of production, and marketing.

Following are some examples of sources of EWSs:

1. External Sources – these are sources that are not part of or external to the enterprise. These may be in the form of events, news reports, studies, plans, etc.
• Natural disasters and calamities
• Political change and upheavals
• Wars and insurgencies
• Economic Crisis
• Lifestyle changes
• Technology advancement
• Changing weather patterns
• New and changing markets

2. Internal Sources – these are sources that can be found within the borrower’s physical boundaries, structures, systems, and territorial influence.
• Management (changes in ownership)
• Movements (people, offices and functions)
• Financial Statements
• Employees (news or gossip)
• Management and Production reports
• C I reports
• Legal problems
• Compliance to government rules and regulations




Early warning signals exist in abundance throughout any organization. They are in pieces of conversation you had with an office mate over lunch, papers given by competitors at conferences, gossip from suppliers, a conclusion a colleague came to after reading a press release, or in the knowledge of someone down the hall who years ago worked on a project that is now becoming important.

For example, a rise in the level of an enterprise’s receivables is a warning signal that may mean any of the following: our collection system has become inefficient, our buyers are having collection problems themselves, the market for our products is shrinking and retail sales are lower that’s why orders are not being paid on time, or there is a big increase in orders consequently resulting to an increase in receivables.

In any case, the sharp change, whether an increase or decrease, should turn on the alarm bells and should immediately cause us to investigate, identify and prepare for the possible threat. We can either prevent the threat from happening, or we can mitigate its adverse effects.

The problem with capturing this data is that the value of it is not often recognized by the person who has it. The backbone of such an early warning process and culture must be a technology for the capture, collection, assembly and dissemination of early warning signals. Usually, this involves a management information system (computerization of business processes and database management) and the ability to generate information from a database.

It must be easy to use, and it must provide value for the person entering the information, or they won't do it. This information then has to be sorted and pushed to the person who can make sense of it, who can see the pattern.

The process must separate noise from the true early warnings signals; the technology and the culture of the company must mesh. While having the technology to help us manage risk is a pre-requisite for effective use of EWSs, it is of greater importance that the person tasked to use the technology believes (this is the “culture”) in the EWSMS and takes seriously the process of valuing the EWSs and mitigating the risks identified.

In using the EWSMS, we should be guided by the following procedures (refer to EWSMS framework diagram):

• EWS generation

Involves maximum use of the senses and the tools needed to generate data and information. This requires to a large extent the monitoring of the internal and external environments of the business.

• Risk Assessment

Risks or uncertainties that affect the project or the borrower are identified based on the EWSs generated and observed.

• Risk Analysis

The effects of the risks identified are quantified. It is usually done by identifying risks and quantifying each risk’s probability of occurrence and the potential severity of its impact. The impact may be expressed as a range of values, with a confidence level, or as a probability distribution.

• Risk Mitigation

Risk mitigation involves preparation of a risk management plan. This is a list of action steps to do the following:
a.) Eliminate or reduce the probability of a threat occurring
b.) Eliminate or reduce the impact of the threat if it does occur.
c.) Ensure or increase the probability of an opportunity occurring.
d.) Increase the impact of an opportunity if it does occur.


• Risk Control

Risk control is the implementation of the risk management plan. This step includes the triggers referred to in risk mitigation. A key element of the implementation process is the continual tracking and reporting of progress with special attention given to variances and deviations along the way.