What is Business Risk?
A company’s or organisation’s exposure to the possibility of experiencing decreased profits or complete failure is known as “business risk.” A business risk is anything that could potentially hinder the company’s progress toward its financial objectives. Many disparate elements can interact to increase the potential for loss for a company. Business risk can be increased when decisions are made at the highest levels of an organisation that are counter to the best interests of the company.
It’s possible, though, that a company’s exposure to risk has an external source. As a result, it’s impossible for a business to completely avoid peril. However, there are ways to reduce the impact of these risks on your business, and most companies do this by implementing a business risk management strategy.
Understanding Business Risk
A company’s ability to generate profits for their shareholders and other stakeholders could be jeopardised by the presence of significant business risk. The chief executive officer (CEO) of a company bears ultimate responsibility for the success or failure of the company, and his or her decisions can have a significant impact on the company’s bottom line.
Among the many variables that can affect a company’s business risk are:
- Sales volumes, product popularity, and consumer tastes
- Retail and production expenses
- Global economic conditions
- Rules set by the government
A lower debt ratio in the capital structure may be chosen by a company with a higher business risk profile to guarantee the regular payment of all debts. In the event of a decline in revenues, a company with a low debt ratio may be unable to meet its debt obligations (and this may lead to bankruptcy). On the other hand, when revenues rise, a firm with a low debt ratio is better able to meet its financial commitments thanks to increased profits.
Analysts use just four straightforward ratios—contribution margin, operation leverage effect, financial leverage effect, and total leverage effect—to quantify risk. Analysts can use statistical methods for more involved computations. Strategic risk, compliance risk, operational risk, and reputational risk are the most common types of business risk.
Diverse Forms of Corporate Risks
Any time a company deviates from its business model or plan, it introduces strategic business risk. It can be difficult, if not impossible, for a company to achieve its objectives if its operations deviate from its business model. An example of a strategic risk for Walmart would be if the company chose to position itself as the low-cost provider and Target then decided to undercut Walmart’s prices.
Compliance risk is the second category of dangers that a company faces. It is in highly regulated sectors and industries where the risk of noncompliance is greatest. The wine industry in the United States, for instance, employs a three-tier distribution system in which wholesalers sell wine to retailers who in turn sell it to consumers (who then sells it to consumers). Due to this system, wineries can no longer sell their wares directly to stores.
Numerous states in the United States, however, do not use this distribution system, so there is a risk of noncompliance when a company fails to learn the specific regulations of the jurisdiction in which it operates. A company runs the risk of breaking distribution laws in individual states if this happens.
Thirdly, operational risk is a form of business risk. This threat comes from within the company and is most evident when normal business functions are ineffective. When HSBC’s internal anti-money laundering operations team failed to effectively prevent money laundering in Mexico in 2012, the bank faced a significant operational risk and was penalised heavily by the U.S. Department of Justice.
If a company’s reputation is damaged, for whatever reason (including but not limited to the occurrence of an event that was the result of a previous business risk), it runs the risk of losing customers and seeing brand loyalty plummet. HSBC’s standing in the market dropped after it was penalised for lax anti-money laundering procedures and subsequent fine.
The unpredictability of business risk makes it impossible to eliminate it entirely. Yet, there are a variety of tactics that companies can use to mitigate strategic, compliance, operational, and reputational risks.
When developing a business strategy, the first step for most brands is to pinpoint all potential danger areas. These dangers can come from both external sources and internal factors. It’s crucial to take measures to reduce business risks as soon as they become apparent. If there are any risks that can be identified, management should devise a strategy to mitigate them before they escalate.
Once a company’s management has devised a strategy for mitigating a risk, they should take the extra step of documenting the process in case a similar situation arises in the future. After all, risks in business tend to recur in cycles, just like the economy.
At the end of the day, most businesses implement some sort of risk management strategy. This can happen either before the company starts up or after it has encountered a setback. The goal of risk management is to make a company more resilient to the various threats it faces. In the event of an emergency, the plan should include tried and true ideas and protocols.