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Business Risk

A threat to the company’s ability to achieve its financial goals

What is Business Risk?

Business risk refers to a threat to the company’s ability to achieve its financial goals. In business, a risk means that a company’s or an organization’s plans may not turn out as originally planned or that it may not meet its target.

 

Business Risk

 

Such risks cannot be blamed always on the account or on the owner of the company as it can be influenced by various external factors, which may include rising prices of raw materials for production, growing competition, and even changes and additions to the already existing regulations set by the government.

 

How to Identify Business Risks

As risks are inherent to every environment and business, they cannot be avoided and so must be addressed head-on to minimize their impact. The first step to doing it is to identify the risks in order to come up with a risk management strategy.

 

1. Analyze the sources that may trigger problems

It is important to identify and analyze the sources that can cause a problem. The triggers can be internal and external.

 

2. Act now

Managers shouldn’t wait for perceived problems to become actual problems before they start doing something. The moment a problem is deemed to become a threat, it should immediately be dealt with among the executives and a plan of action should be created should it become a full-blown concern.

 

3. Involve employees

Identifying risks is not the sole responsibility of the managers and top-ranking officials. It is as much the role employees should take. Management should involve their employees in identifying the risks that they see in their respective departments and train them to handle such risks at their level.

 

4. Make a list of industry-specific risks

By looking outside of the box and into the industry where the company operates in, managers will be able to identify the possible risks that the business may face. If the same risks happen to other companies in the same industry, there is a likely chance that it will happen to all other companies. Also, businesses should be ready with a list of solutions or steps to address the risks.

 

5. Create a record of risks

Sometimes, risks happen over and over. By creating a record of all the risks experienced by the company since it started, the business will be able to do a regular review of past events in order to establish perhaps a pattern that will better prepare the company for future risks.

 

Types of Risks in Business

Risks come in different forms that every business should be aware of. Below are the different types of business risks:

 

1. Strategic risk

Strategic risks happen to businesses as they operate within a particular time, which means that it can happen anytime. For example, a company manufacturing an anti-mosquito lotion may suddenly see a decline in its sales because people’s preferences have changed, and they now want a spray mosquito repellent because it doesn’t feel warm. To avoid having to face such a risk, companies will need to implement a real-time feedback system to know what its customers want.

 

2. Compliance risk

Compliance risk involves companies having to comply with new rules that are set by the government or by any other governing body. For example, there may be a new minimum wage that must be implemented immediately.

 

3. Financial risk

Financial risk is about the financial health of the company. Can the company afford to offer installment payments to its customers? How many customers can it offer such installment scheme? Can it handle business operations when two or three of these customers are not able to make their payment on time?

 

4. Operational risk

Operational risk occurs within the business’ system or processes. For example, one of its equipment bugs down and the target output is still unmet. What will the company do if one of its machine operators got into an accident during work hours?

 

Causes of Business Risks

There are basically three causes of business risk:

 

1. Natural causes

Natural causes of risk include flooding, earthquakes, cyclones, and other natural disasters that can lead to the loss of lives and property. For example, a delivery truck is on its way to delivering the orders of one customer but was met with a cyclone along the way, causing an accident. In order to counter such causes, businesses need to take comprehensive insurance coverage.

 

2. Human causes

Human causes of risk refer to negligence at work, strikes, work stoppages, and mismanagement.

 

3. Economic causes

Economic causes involve rising prices of raw materials and minimum wage, rising interest rates for borrowing, and competition.

 

How to Manage Business Risks

Business risks may be inevitable, but there are several ways to minimize their impact, such as:

 

1. Avoid the risk

It may sound ironic to avoid the risk when we say that it is inevitable. But what is meant here is that companies should go the other way, instead of the one that leads to the risk. Managers should think of alternatives in order to not have to face the risk.

 

2. Prevent the risk

In the example of the delivery truck above, it would help prevent the risk if companies check on the weather prior to sending out deliveries in order to make sure they reach their destination safely. If there is a deemed risk, then they should prevent it from happening.

 

3. Retain the risk

Sometimes, there are risks that cannot be avoided or prevented. Companies can choose to retain said risks while putting up safety nets. For example, since all businesses need to access the internet where hackers abound, they may put stronger firewalls and other protective measures to ensure their company’s safety.

 

More Resources

CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Business Life Cycle
  • Idiosyncratic Risk
  • Loss Aversion
  • RAID Log

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