Definition of Business Risk
Business risk can be defined as the company experiencing less than expected profit or making a loss during a particular period instead of earning profit and this can be driven by several factors like sales revenue, the volume of sales made, the price per unit, raw material cost, competition factor, and macro-economic factors.
What is Business Risk?
Business risk is a scenario when a business is anticipating a certain amount of profit but instead cannot earn to that extent or in severe cases makes a loss instead of earning a profit. It can be defined as the exposure of a business to several factors like sales revenue, the volume of sales made, the price per unit, raw material cost, competition factor, and macroeconomic factors which can lower the profit or ultimately lead the business to loss. This can also be defined as factors that disrupt the company’s ability to perform or achieve its goal.
These risks can come from multiple points and we cannot hold the manager or senior management accountable for them. These risks may come from within the organization or even outside the firm i.e. either from certain factors related to the business itself or from macro-economic factors like regulation or government decisions. Thus a risk management strategy can play like a buffer to cushion the business against these types of risks to a certain extent.
Characteristics of Business Risk
The characteristics are as follows:
- Time: In older times business risks were less but in modern times with the increasing competition and advent of technology business risks have increased.
- The size of business: Small businesses experience low risk because they are flexible in operations and highly adaptable whereas the same is not true for big business firms.
- Nature of Business: In the case of a business that is in the manufacture or market of necessary products business risk is low because demand is also high whereas in the case of business in the field of luxury goods risks are high.
- Competition: Business which is operating in a highly competitive market is exposed to more risk than ones that operate in relatively less competition.
- Management competency: The more experienced and competent management lower the chances of the business making a loss.
- Age of business: Older businesses are less exposed to business risk as they have a set customer base and the experience of handling such risks.
Types of Business Risk
The different types are as follows:
- Natural Types: Risk which is faced by the business on the grounds of natural calamity like floods, earthquakes, etc. These are uncontrollable and cannot be forecasted earlier too.
- Political Types: These risks generate from the political scenario prevalent in the country and decisions of political parties which may bring about price regulations lowering the profit margin, high tax rates eating a lot of profit, and strict rules on a day-to-day business.
- Social Types: These kinds of risks are generally driven by customer behavior or common social practice. Common examples of such types are changes in fashion, change in the preference of customers, change in income, and change in the consumption of customers.
- Economic Types: Risks brought in by economic factors like inflation, economic recession impacting the demand-supply chain, and a higher rate of interest eating away profit.
- Managerial Types: Risks driven by the decision of the management which maybe not be favorable to the business.
- Competitive Types: Risks are drive-by fierce competition in the market due to the entry of a lot number of players which may threaten the survival of others.
- Technological Types: Risks driven by the advent of the latest technology or ever-changing technology that may substitute the product or the process of manufacturing a product with the latest one or methods.
A practical example of the same can be the case of the Sony Walkman where a very popular and widely used audio device was totally substituted by newer products and consumer behavior and the so-called Walkman was totally stopped. The risk that Sony faced, in this case, was Technology drive business risk and Social driven business risk. On grounds of technology, Apple and other companies came with more handy devices like I-pod and Sony Walkman stood nowhere near to it in terms of feature and ease of use. On the grounds of social-driven business risk, it was the customers who were more driven by the trend of using a smaller and latest device like the I-pod instead of a Walkman. Thus the entire business model of Sony Walkman ended in making a loss and finally had to shut down its business.
Factors Affecting Business Risk
The several factors affecting the same are as follows:
- Preference of Customers: Consumer preference play a major role in the business as it is ultimately the customer who is the king and the taste and choice of customers drive the market.
- Demand and Volumes of Sales: The demand-supply chain prevailing in the market and thus the volume of sales will impact the profit-making of every business.
- Per Unit Price and Raw Material Cost: The profitability of every company depends on the cost of raw materials and finally per unit price of the product which decides based on the potentiality of sales and how much profit/loss it can make.
- Competition: Competition plays a major role as businesses that are operating in a highly competitive market are exposed to more risk than the ones which operate in relatively less competition.
- Economic Scenario: Risks brought in by economic factors like inflation, economic recession impacting the demand-supply chain, and a higher rate of interest eating away profit.
- Government Regulations: Regulations brought in by the government can eat away a lot of profit and also bring a barrier to the ease of doing business.
How to Manage Business Risks?
Few techniques to manage or avoid the risk are as follows:
- Risk Management Strategy: Nowadays business is coming up with a separate team that is involved in studying or managing the risk and thus bringing in methods to keep the risk to a minimum if not totally avoidable.
- Identify Risk: A sound business plan can identify or analyze the threat to the business at the very start rather than not waiting for something to happen. This requires a more proactive behavior of the management.
- Recording of Risk: The moment the management is done with a plan to deal with the risk, it is essential to record it so that in the future if any same situation arises the management can easily deal with it then as risks are not static and can repeat during the business cycle.
Difference between Business Risk vs Financial Risk
Business risk means not being able to make the firm profitable whereas financial risk means not being able to pay off the debt or meet the financial obligations of the firm. Business risk is purely operational in nature whereas financial risk is related to debt payment. Business risks are not controllable and thus unavoidable whereas financial risks are controllable and avoidable too. Business risks are prevalent as long as the business operates whereas a financial risk exists until the time equity financing is increasing.
Business risk can be managed by bringing in systematic measures of conducting day to day operations and minimizing the cost whereas financial risk can be managed by reducing the debt level and increasing the equity level. Business risk can be measured by looking into the EBIT whereas financial risk can be measured by looking into the financial leverage numbers and debt-asset ratio.
Advantages and Disadvantages of Business Risk
The advantages and disadvantages of the same are as follows:
- It makes the business think out of the box and consider facts like improving operations.
- This faced by businesses makes the business more adaptable to future scenarios and changes.
- This faced by business makes a firm work more effectively and efficiently minimizing the cost of operations.
- It makes the business ready for the current consumer trend and also adheres to the statement that the customer is king.
- At times to manage the risk the company may incur more losses and costs of expenditure.
- It involves a lot of costs to manage the risk in the form of change in technology or assets or teams.
- Higher salaried costs in the form of raising a team just to study and manage the risk.
- May impact the entire business which can lead to the shutdown of the firm.
- Business impacts the profitability of the firm.
Business risk is a common factor that every business has to face with changing times, consumer behavior, and technology. It can be systematically managed to some extent if the management is proactive to prevent the profitability of the company goes down. It has also given the scope of employment these days as companies prefer to hire people who have expertise in studying and managing risk.
This is a guide to Business Risk. Here we discuss characteristics, examples, types, and advantages and disadvantages. You can also go through our other related articles to learn more –
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- Risk/Reward Ratio
- Relative Risk Reduction Formula
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