What is Business Risk?
The chance of inadequate profits or even losses due to uncertainties or unexpected events is known as Business Risk. In simpler terms, business risk is the possibility of incurring losses or generating less profit than projected. These factors are beyond the control of businessmen.
For example, there is a decrease or change in the demand for a firm’s product, as a result of a change in the product’s quality, a change in the market scenario, and an increase or decrease in competition. As a result, a fall in demand will result in lower product sales, which will lead to a decrease in firm profit.
It is the convergence of internal and external factors that create risks to a firm and its management team. These risks might arise from:
- The external business environment, which includes macroeconomic influences outside management’s control (like inflation, foreign exchange rates, or prevailing interest rates).
- Industry-specific risks, such as industry concentration, regulatory risk, entry barriers, disruption risk, and other aspects.
- Concerns at the corporate or business level, such as inadequate management, reputational risk, a toxic corporate culture, and customer or supplier concentration risk.
Types of Risk
Business Risk can be of two types: Pure Risks and Speculative Risk
1) Pure Risk
Pure risk refers to risks that are uncontrollable by humans and result in a loss or no loss with no chance of financial gain. Pure risk situations include fires, floods, and other natural disasters, as well as unexpected incidents, such as terrorist actions or untimely deaths.
Risk managers handle risk in four ways: they minimize, avoid, accept, or transfer it. Many forms of pure risk are dealt with by getting insurance coverage for the possible loss, so transferring the risk to an insurance provider.
2) Speculative Risk
Speculative risk is a type of risk that, when taken, might result in an unpredictable amount of gain or loss. All theoretical risks are decided consciously and are not only the result of uncontrollable events. Speculative risk differs from pure risk in that there is a chance of both a gain and a loss.
Since an investor has no way of knowing whether an investment will be a spectacular success or a complete disaster, nearly all investing techniques include such speculative risks. Contract options are an asset that carries both investing risk and risk you can cover.
Nature of Business Risk
Business risk refers to the possibility that a company’s earnings will be lower than expected or it will lose money instead of profit. Numerous factors impact business risk, including sales volume, per-unit pricing, input costs, competition, the broader economic situation, and government restrictions.
1) Uncertainties in Business
Uncertainties cause business risk. Uncertainties refer to a lack of knowledge. It is a situation when you do not know what will happen in the future. Uncertainties affecting a firm include changes in government policy, changes in demand, changes in technology, etc.
2) Risk is an essential part of every business
No business firm can avoid risk. Risk can be reduced, but not eliminated. However, a business company can minimize business risks by avoiding too many risky transactions, purchasing insurance, making provisions in current profits (e.g., provision for bad and dubious debts), and using preventative measures, such as firefighting systems.
3) Degree of risk depends on the nature and size of business
Small businesses are less exposed to business risks since their operations are flexible and can rapidly adjust to changing conditions. On the other side, the larger the firm, the less flexible it is. As a result, larger companies are more vulnerable to business risks.
There is less risk in the case of business companies engaged in the manufacture/purchase of necessary commodities, such as salt, sugar, oil, cotton, etc., because demand for most of the necessary items is inelastic or less elastic. Business firms engaged in the manufacturing or acquisition of luxury products, on the other hand are more exposed to business risks since the demand for luxury things is highly elastic.
4) Profit is the reward for taking risks
No risk, no gain is an age-old business philosophy that applies to all sorts of businesses. When a company or organisation is willing to take a risk, the chances of profit are higher than the company or organisation who is unwilling to take a risk. Hence Profit is the payoff for taking risks since the larger the risk, the higher the chance of profit.
Causes of Business Risks
Some risks are common to all humans everywhere, such as fire, robbery, flood, earthquakes, cyclones, drought, war, civil uprisings, and so on. As such, these are not risks that are specific to business. Furthermore, some risks are insurable through insurance firms. As a result, in today’s world with many different forms and sorts of insurance, these risks cannot be considered risks in the true meaning of the term. As a result, business risks are those that are unique to the company and are not insurable.
1) Natural Causes
Nature is a self-contained phenomenon over which humans have no control. Natural disasters such as earthquakes, floods, droughts, and famines have a significant impact on businesses and can lead to major losses. Natural causes are the sort of unpredictable circumstances against which humans have no control. Natural risks are those that arise as a result of nature’s activity and are hence uncontrollable. For example, Farmers face a major risk if rainfall does not occur on time or if heavy rainfall causes flooding. Again, there is a chance that a hail storm would destroy crops in the field.
2) Human Causes
Human causes are associated with the possibility of loss due to human resources of the organisation. Employee dishonesty may result in significant losses for businesses. For example, employees may leak a corporate secret to a rival or conduct fraud, resulting in significant losses due to resource waste. Employees may disrupt production by going on strike, rioting, and so forth. This might also result in a significant loss of business situation.
A few examples of Human Causes
- Bad Debts due to non-payment of debts by debtor.
- Misappropriation of cash by employees
- Strike or low productivity by workers
- Damage of machines by employees
- Leakage of business secrets to competitors
3) Economic Causes
Economic factors are associated with the possibility of loss as a result of change in market conditions. There may be a shift in the level of competitiveness. Even changes in government policy have a significant impact on business. Uncertainties about the demand for goods, competition, pricing, collection of customer dues, change in technology or technique of production, and so on are also included in economic causes of risk. It also includes financial problems, such as an increase in interest rates for borrowing, levy of increased taxes, and so on, since they result in greater unexpected costs of operation or business. All of these have a direct influence on the profits.
4) Physical and Other Factors
There are also a number of other factors. All physical causes that result in asset damage are considered physical causes. For example, changes in technology may result in machinery becoming outdated, use of old technology, and mechanical defects may also result in asset damage, such as the bursting of a boiler, an employee accident, etc.
How to deal with Risks?
1) Prioritising the risk
Prioritising risks and threats should always be the first step in developing a risk management plan. Using a scale based approach on the probability of each risk occurring, you may do this:
Very likely to take place
Some probability of occurrence
Low probability of occurrence
Very low probability of occurring
Naturally, a risk that falls into the top category should take priority over the others, and a strategy should be put in place to avoid, or at least mitigate, these risks. There is a catch, though. Priority should be given to a risk if it is on a lower rank, but has the potential to cause greater financial harm.
2) Buying Insurance
Determine the types of insurance that your company will need by evaluating liabilities and legal requirements. This might have included: life insurance, disability protection, specialised insurance, operation-specific insurance. When compared to the potential cost of uninsured risk, purchasing insurance offers you the opportunity to shift your risk to insurance firms for a relatively low fee.
3) Implement a programme for quality control
If you want a successful business, having a solid reputation is essential. Customer service is essential for success. To ensure the highest quality, make sure to test your goods and services. You will have the chance to make necessary adjustments by analysing and testing what you’re giving. Consideration should also be given to improving your testing and analysis methods.
4) Restrict High-Risk Customers
If you’re just starting a business, put in place a policy that requires customers with bad credit to pay in advance. This will assist you in avoiding issues later on. You need a method to spot high-risk borrowers with bad credit in advance in order to achieve this.
Some other points that can help to deal with Risks are as follows:
- Too risky transactions should be avoided.
- Preventive measures should be uses, like firefighting devices, etc.
- Provisions should be made in the current earning.
- Risks should be shared with other enterprises. For example, an agreement can be signed with other enterprises to share losses in case of falling prices.
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