Business Risk – Meaning, Causes, How to Reduce and More

Business risk is anything that hampers a company from achieving its objectives, such as generating profits. These risks could even threaten the company’s sustainability in the long run. These risks are uncertain or unexpected events over which business usually has no control.

Business risks can be because of internal factors or from external factors, such as a new law from the government. A few other examples of business risks are a new competitor, a rise in input cost, a change in customer tastes and preferences, new technology, etc.

As said above that, a business may not have control over these risks. But they can try to minimize the impact of these risks by using a risk management strategy.

Causes of Business Risk

There are primarily three causes of business risks:

Natural Causes

These are the causes on which human beings have no control. For example, an earthquake, virus outbreak, flood, and more. It usually affects all industries across the country.

Human Causes

These causes include risks that may result due to human error. For example, dishonest employees leak business secrets to a competitor or intentionally avoid work. Human causes also include strikes, fatigue, negligence, etc. Also, factors such as changes in taste and preferences come under human causes.

Economic Causes

These causes include a rise in the cost of raw materials, competition, any new government policy, and more.

Types of Business Risk

Following are the types of business risks:

Strategic Risk

A successful strategy is essential for a business. And, if a company fails to come up with one, then it could face the consequences. For example, BlackBerry was the leader in the smartphone segment earlier. But after Apple came out with touch screen phones, the Canadian company lost its market share. BlackBerry was not quick to come up with a strategy to make touch phones.

Operational Risk

It is also because of internal factors. For instance, if machinery stops working or the raw material doesn’t arrive in time, production will stop, resulting in losses. Though it is challenging to predict operational risks, businesses can minimize these losses by quickly addressing the concerns. For example, having an in-house technician will help resolve the issue soon. Also, regular or preventive maintenance of the machinery would lower the chances of a breakdown.

Reputation Risk

This risk relates to the goodwill that a company enjoys in a market. If in case, the company loses its reputation in the market, there are chances that it will lose its customers as well. For example, if a mobile company faces accusations of making mobiles that pose a danger to health, then customers would stop buying them.

Also Read: Legal Risks

Compliance Risk

A business needs to follow a set of guidelines and legislation. If a company stops following it or fails to comply with it thoroughly, then it could be difficult for it to continue its business for long. To minimize such risk, the company must regularly evaluate the guidelines and legislation. Also, the company must monitor whether or not it is following them fully.

Financial Risk

Financial risk relates to the financial terms that a company offers to its customers. A business must evaluate whether or not it could sell goods on credit to the customers. Or credit should be given to how many customers? Will it be able to survive if a few customers are unable to pay? What amount could be provided as a credit to customers?

Business Risk

How to identify a Business Risk?

The following tips can help a business identify business risks:

  • A risk can trigger internally or externally. Thus, a company needs to keep an eye on the sources that can turn into a threat.
  • As soon as a risk manager sees any problem, he or she must not wait for it to become a threat. Instead, the manager should deal with it immediately.
  • Management must encourage employees to speak freely on any potential risk they come across in their department. Moreover, employees should be given to deal with such risks at their level at the initial stage.
  • A risk manager must try to identify the risks that other companies in the same industry face. If others face it, there are good chances that your company may also meet the same risk.
  • Some risks arise over and over. Thus, a risk manager should keep a record of all the risks that a company faced since it started. Regular reviewing of the past events may help a risk manager predict the arrival of future risk.

Measuring Business Risks

These are risks that a business can quantify, while some risks can’t be quantified. For the risks that can be quantified, a company can use ratio analysis. For example, a company can use various liquidity ratios, or leverage ratios, or profitability ratios. A point to note is that different situations will require the use of different ratios.

On the other hand, the company will have to use its due diligence for the risks that can’t be quantified. Or, it can develop or define specific, quantifiable parameters, which will tell about those risks. For example, to measure strategic risk, a company can look at the demand and supply. Or, to check its goodwill, it can perform a survey from time to time.

Reduce or Manage Business Risks

As said in the beginning, a business can’t completely do away with business risk. What it can do is make efforts to manage or minimize these risks. Following are how a company can survive or reduce business risks:

  1. Reduction of Unnecessary Costs

    A company must always strive to reduce unnecessary costs. These cost savings come in very handy during adverse business conditions or when the company faces any risk.

  2. Balance between Debt and Equity

    The capital structure of a business should be such that it doesn’t have a high debt cost every month. If a company feels it won’t be able to manage its debt, then it should use equity financing only.

  3. Identification of Potential Risk

    Identifying potential risks is also a very effective strategy. It would help to scale down the impact if and when it occurs. For instance, a company must have a backup plan ready for what it needs to do if a competitor comes with an aggressive price strategy.

  4. Employee Involvement

    A company must involve employees in its decision-making. The top management may not always have all the information. So, the opinion of employees could prove valuable in identifying risks. For instance, an employee operating machinery would have an idea of when it could break down.

Risk Management Strategy

The best tool to minimize risk is to have a reliable and effective risk management strategy. Most of the things discussed above, including measures to reduce or manage business risks and identify and measure business risks, are part of the risk management strategy.

An effective risk management strategy helps the company to identify risks early. It also guides it on what to do or what actions to take during adverse conditions. The risk management strategy should include tested ideas and procedures. Moreover, a company should also update or evaluate its policy from time to time to ensure that it stays relevant or does not get outdated.

Read more on – Business Risk vs Financial Risk.

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Sanjay Borad

Sanjay Bulaki Borad

MBA-Finance, CMA, CS, Insolvency Professional, B'Com

Sanjay Borad, Founder of eFinanceManagement, is a Management Consultant with 7 years of MNC experience and 11 years in Consultancy. He caters to clients with turnovers from 200 Million to 12,000 Million, including listed entities, and has vast industry experience in over 20 sectors. Additionally, he serves as a visiting faculty for Finance and Costing in MBA Colleges and CA, CMA Coaching Classes.

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