Business Risks

Business risk is common in among all business types, thus the importance of effective risk management cannot be overstated. Business risk affects a business's ability to operate properly and succeed financially. Therefore, understanding business risk is essential for all types of business managers. Let's take a closer look.

Business Risk Definition

Avoiding risk is an impossible task for businesses, but controlling and properly managing risk is achievable. Before we continue with this, it is important that we understand the term 'business risk'.

Forces that create business risk can come from internal sources, such as a poor management structure, bad publicity, theft, or the loss of talented employees. External forces may also be at play, such as the increasing prices of raw materials needed for production, increased competition, changes in customer demand, natural disasters, or changes to government or market policy.

Such forces make it impossible for businesses to avoid risk completely as they are unpredictable and can’t be controlled by the business. However, there are steps that can be taken by businesses in order to avoid these risks. An example is creating a risk management strategy.

Business Risk Types and Examples

There are five main types of risk a business may face:

• Strategic risk

• Operational risk

• Financial risk

• Compliance risk

• Reputation risk.

Fig. 1 - Types of business risk

1. Strategic risk

This risk arises when a previously laid-out business strategy becomes less effective or becomes no longer effective in a way that impacts business profit generation and growth, thus limiting businesses from reaching their set goals.

The risk can occur with changes in technology, the entrance of new competitors, changes in the business strategy of a direct competitor, or waning customer interest. To overcome this risk, businesses have to adapt their strategy.

2. Operational risk

This is a risk that arises inside the business, hence it can be termed an internal risk. Operational risk arises from the business's daily activity. This can include technical failure, inappropriate decision-making, or employee-related issues. However, it is important to note that sometimes operational risks may be due to external events such as natural disasters, power outages, etc.

3. Financial risk

Although all types of business risks have an impact on the business's finances, the financial type, as the term suggests, means the risk of sudden financial loss. This may arise due to changes in market conditions, providing credit to customers, and company debt.

An example of financial risk is selling your business's product on credit to 60 percent of your regular customers. This puts your business at great financial risk due to the fact that your customers may not or may not be able to pay for the services offered to them on credit.

4. Compliance risk

This type of business risk is common in highly regulated industries. Compliance risk arises from businesses not following industry operations regulations in their state. Compliance risk may also arise upon introduction of new business operation regulations, which can significantly affect a business's strategy.

5. Reputation risk

The reputation of a company is important. A company with a ruined reputation is at risk of losing public backing and customers, thus negatively impacting its brand loyalty.

Causes of Business Risk

There are three categories for causes of business risk:

1. Natural causes

Risk may occur due to natural causes, or non-man-made factors that hamper the operations of a business. This may include natural disasters such as earthquakes, hurricanes, floods, etc. Businesses can defend against this risk by taking out insurance coverage to soften the effects of these disasters on their activities.

2. Human causes

Business risk due to human causes refers to human factors affecting the operations of a business. These factors may include employee issues, strikes, ineffective business management, poor decision-making, or changing consumer choices.

3. Economic causes

Economic factors may contribute to risk that limits businesses from reaching their financial goals. This may include increased cost of raw materials and labour, competition, market regulations, government policies, increasing interest rates, etc.

Accessing Business Risk

Business risks are generally unavoidable, hence the need for regular assessments. Businesses should aim to identify these risks and address them immediately. They can do this through the following:

• Check and identify various sources that can promote business risk.

• Start planning/implementing a strategy to deal with potential business risk.

• Involve your employees in the identification of and dealing with potential business risks.

• Identify business risks already experienced by direct competitors and create a strategy to deal with them.

• Create a catalogue of business risks previously faced - and their solutions - as they may resurface again.

• Assess the potential threat a risk can have on your business.

• Always revisit your business risk control strategy.

Managing Business Risk

Below are ways to manage business risks:

• Prepare a business plan that outlines future possibilities of market changes and the steps the business can take to mitigate their effects.

• Invest in training of employees to deal with unsatisfied customers or natural disasters (e.g. flooding).

• Employ experts and consultants who have specialised knowledge on how to deal with business risks.

• Prioritise business risks on a scale of likely occurrence.

• Insure business assets.

• Diversification, also known as selling new products in different markets, might minimise the risk of competitors taking the business's market share.

• Create a risk management team for your business.

• Give a credit limit to high-risk customers.

• Provide quality assurance for your products to protect your reputation.

• Stay updated about the market, consumer interest, and your competitors and regulations, and embrace changes in the market.

Business risk is impossible to avoid, so understanding and constantly accessing the likelihood of potential risks is important in managing your risk. Business risk, no matter the form taken, impacts the firm's financial goals and can cause a business to fail.