Business risk refers to the possibility of inadequate profits or even losses due to uncertainties e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government policy, obsolescence etc. Every business organization contains various risk elements while doing the business. Business risk implies uncertainty in profits or danger of loss and the events that could pose a risk due to some unforeseen events in future, which causes business to fail.
For example, an owner of a business may face different risks like in production, risks due to irregular supply of raw materials, machinery breakdown, labor unrest, etc. In marketing, risks may arise due to different market price fluctuations, changing trends and fashions, error in sales forecasting, etc. In addition, there may be loss of assets of the firm due to fire, flood, earthquakes, riots or war and political unrest which may cause unwanted interruptions in the business operations. Thus business risks may take place in different forms depending upon the nature and size of the business.
Risk means that there is a chance that you won’t receive a return on your investment. It is an exposure to danger to your bottom line. When you are in business, you need to consider the kinds of events that could pose a risk to your business and take steps to mitigate them.
Business risks can arise due to the influence by two major risks: internal risks (risks arising from the events taking place within the organization) and external risks (risks arising from the events taking place outside the organization).
Internal risks arise from factors (endogenous variables, which can be controlled) such as human factors (talent management, strikes), technological factors (emerging technologies), physical factors (failure of machines, fire or theft), operational factors (access to credit, cost cutting, advertisement). External risks arise from factors (exogenous variables, which cannot be controlled) such as economic factors (market risks, pricing pressure), natural factors (floods, earthquakes), political factors (compliance and regulations of government).
Business risk is the possibility a company will have lower than anticipated profits or experience a loss rather than taking a profit. Business risk is influenced by numerous factors, including sales volume, per-unit price, input costs, competition, the overall economic climate and government regulations.A company with a higher business risk should choose a capital structure that has a lower debt ratio to ensure it can meet its financial obligations at all times.
Business risk impairs a company’s ability to provide its investors and stakeholders with adequate returns. The company is also exposed to financial risk, liquidity risk, systematic risk, exchange-rate risk and country-specific risk. This makes it increasingly important to minimize business risk. To calculate the risk, analysts use four simple ratios: contribution margin, operation leverage effect, financial leverage effect and total leverage effect. For more complex calculations, analysts can incorporate statistical methods.
Specific Types of Business Risk
Business risk usually occurs in one of four ways: strategic risk, compliance risk, operational risk and reputational risk.
Strategic risk arises when the implementation of a business does not go according to the business plan. A company’s strategy becomes less effective over time, and it struggles to reach its defined goals. If, for example, Wal-Mart strategically positions itself as a low-cost provider and Target decides to undercut Wal-Mart’s prices, this becomes strategic risk.
The second form of business risk is compliance risk. This type of risk arises in industries and sectors highly regulated with laws. The wine industry, for example, must adhere to the three-tier system of distribution, where it is a requirement for a wholesaler to sell wine to a retailer, who in turn sells it to the end consumer. Wineries cannot sell directly to retail stores. However, there are 18 states that do not have this type of distribution system, and compliance risk arises when a brand fails to understand the individual requirements and becomes noncompliant with state-specific distribution laws.
The third type of business risk is operational risk. This risk arises when the day-to-day operations of a company fail to perform. HSBC, for example, faced operational risk and a heavy fine when its internal anti-money laundering operations team was unable to adequately stop money laundering in Mexico.
Any time a company’s reputation is ruined, either by one of the previous business risks or by something else, it runs the risk of losing customers based on a lack of brand loyalty. Using HSBC as a second example, the company faced high risk of losing its reputation when the $1.9 billion fine was levied for poor anti-money laundering practices.
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