Corporate risks, risk bearing ability and equity

There is a relation between corporate risks, risk bearing ability and equity. In order to assess the risk bearing ability of a corporation, one reference figure is equity, understood as the sum of legal capital and reserves, free reserves and accrued profits. Equity shows the risk bearing ability related to the risk of asset reduction as well as the ability of the corporation to attract new liquidity by increasing debts, in case of a negative free cash flow. Equity is the risk reserve of the corporation. The relation between equity and risk bearing ability allows defining the necessary amount of equity by analyzing the corporate risks. Furthermore, it leads to rules for the valuation of assets, the creation of reserves and as to the board’s duty of care on how to pursue the corporate strategy.