Business risks

The term business risk refers to the possibility of inadequate profits or even losses due to uncertainties
e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government
policy, obsolescence etc .Every business organization contains various risk elements while doing the
business. Business risks implies uncertainty in profits or danger of loss and the events that could pose
a risk due to some unforeseen events in future, which causes business to fail.[1][2][3]
For example, an owner of a business may face different risks like in production,risks due to irregular
supply of raw materials, machinery breakdown, labor unrest, etc. In marketing, risks may arise due to
different market price fluctuations, changing trends and fashions, error in sales forecasting, etc. In
addition, there may be loss of assets of the firm due to fire, flood, earthquakes, riots or war and political
unrest which may cause unwanted interruptions in the business operations. Thus business risks may
take place in different forms depending upon the nature and size of the business.
Business risks can arise due to the influence by two major risks: internal risks (risks arising from the
events taking place within the organization) and external risks (risks arising from the events taking
place outside the organization).[4]
Internal risks arise from factors (endogenous variables, which can be controlled) such as human factors
(talent management, strikes), technological factors (emerging technologies), physical factors (failure of
machines, fire or theft), operational factors (access to credit, cost cutting, advertisement). External risks
arise from factors (exogenous variables, which cannot be controlled) such as economic factors (market
risks, pricing pressure), natural factors (floods, earthquakes), political factors (compliance and
regulations of government).[5][6]

Classification
The Business risk is classified into different 5 main types[7]
1. Strategic Risk: They are the risks associated with the operations of that particular industry.These
kind of risks arise from
1. Business Environment: Buyers and sellers interacting to buy and sell goods and services,
changes in supply and demand, competitive structures and introduction of new
technologies.
2. Transaction: Assets relocation of mergers and acquisitions, spin-offs, alliances and joint
ventures.
3. Investor Relations: Strategy for communicating with individuals who have invested in
the business.
2. Financial Risk: These are the risks associated with the financial structure and transactions of the
particular industry.
3. Operational Risk: These are the risks associated with the operational and administrative
procedures of the particular industry.
4. Compliance Risk(Legal Risk): These are risks associated with the need to comply with the rules
and regulations of the government.
5. Other risks: There would be different risks like natural disaster(floods) and others depend upon
the nature and scale of the industry.
What is 'Business Risk'
Business risk is the possibility a company will have lower than anticipated profits or experience a loss
rather than taking a profit. Business risk is influenced by numerous factors, including sales volume,
per-unit price, input costs, competition, the overall economic climate and government regulations. A
company with a higher business risk should choose a capital structure that has a lower debt ratio to
ensure it can meet its financial obligations at all times.

BREAKING DOWN 'Business Risk'

Business risk impairs a company's ability to provide its investors and stakeholders with adequate
returns. The company is also exposed to financial risk, liquidity risk, systematic risk, exchange-rate risk
and country-specific risk. This makes it increasingly important to minimize business risk. To calculate
the risk, analysts use four simple ratios: contribution margin, operation leverage effect, financial
leverage effect and total leverage effect.

Specific Types of Business Risk

Business risk usually occurs in one of four ways: strategic risk, compliance risk, operational risk and
reputational risk.
Strategic risk arises when the implementation of a business does not go according to the business
model or plan. A company's strategy becomes less effective over time, and it struggles to reach its
defined goals. If, for example, Wal-Mart strategically positions itself as a low-cost provider and Target
decides to undercut Wal-Mart's prices, this becomes strategic risk.
The second form of business risk is compliance risk. This type of risk arises in industries and sectors
highly regulated with laws. The wine industry, for example, must adhere to the three-tier system of
distribution, where it is a requirement for a wholesaler to sell wine to a retailer, who in turn sells it to
the end consumer. Wineries cannot sell directly to retail stores. However, there are 18 states that do not
have this type of distribution system, and compliance risk arises when a brand fails to understand the
individual requirements and becomes noncompliant with state-specific distribution laws.
The third type of business risk is operational risk. This risk arises when the day-to-day operations of a
company fail to perform. HSBC, for example, faced operational risk and a heavy fine when its internal
anti-money laundering operations team was unable to adequately stop money laundering in Mexico.
Any time a company's reputation is ruined, either by one of the previous business risks or by something
else, it runs the risk of losing customers based on a lack of brand loyalty. Using HSBC as a second
example, the company faced high risk of losing its reputation when the $1.9 billion fine was levied for
poor anti-money laundering practices.

Businesses face many types of risks. Some of those risks can be managed with insurance. Im not going
to address those here, but Ill point you to a great site with tons of free information. Check out
www.ClearRisk.com for a comprehensive list of business risks that can be managed by insurance. I
would also strongly recommend that you download and read their free e-book. Its an easy read and
provides a great education on insurance for small and medium businesses. (Disclaimer: My
recommendation is not sponsored and Im not being paid in any way. In fact, Craig Rowe and the
ClearRisk team dont even know Im doing it.)
.
So lets talk about the risks you cant buy insurance for. Obviously every business is going to have risks
that are unique to that business, but they will always fall into three broad categories budget risk,
quality risk and schedule risk. (Check out my post here for details.) Starting with those categories, you
can drill down by using the 5 Coulds Technique (detailed here).
.
As you do the brainstorming, youll find that you come up with a wide range of risks. Here are just a
few that come to mind as Im writing. Im in a manufacturing and retail mindset this morning so the
risks are geared to those kinds of businesses, but many of them apply to service businesses, too. Some
risks are repeated in multiple categories purposely.
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Make sure you read the IMPORTANT NOTE at the bottom of the post!
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Employee Related Risks

Theft
Departure of a key employee
Lack of training
High turnover
Sabotage/intentional misbehavior
Employee disputes
Poor customer service
.

Revenue Related Risks

Competitor enters market
Market size shrinks (local population shrinks, demographics change)
Economic pressure (reduces money available to be spent on your product)
Substitute product becomes available
Customer access disrupted (e.g. road construction in front of your business)
Pricing doesnt match value perceived by customers
.

Expense Related Risks

Material costs increase
High rework expense
High warranty expense
Loss of key supplier
Increased wage expense (tight labor market)
 Increased benefit costs
Loss of lease/increased rent
Increased utility rates
Increased bank charges (interest rates, credit card fees)
.

Quality Related Risks

Poor production process
High rework expense
High warranty expense
Poor customer service
Low quality materials
Poor employee morale
Inadequate equipment/tools
Poor/unattractive packaging
Equipment/tool breakdown
.

Schedule Related Risks

Customers are slow paying
Unfavorable terms from suppliers (e.g. cash in advance)
Late delivery of materials
Lost/misdirected shipments of your product
Slow response of bank, government agency (e.g. loan proceeds, permits, etc.)
Delayed construction/remodel
Slow response to marketing campaign
Equipment/tool breakdown (e.g. internet down, computer virus)

Audit risk (also referred to as residual risk) refers to the risk that an auditor may issue an unqualified
report due to the auditor's failure to detect material misstatement either due to error or fraud. This risk
is composed of inherent risk (IR), control risk (CR) and detection risk (DR), and can be calculated thus:
AR = IR CR DR

IR refers to the risk involved in the nature of business or transaction. Example, transactions involving
exchange of cash may have higher IR than transactions involving settlement by cheques.
CR refers to the risk that a misstatement could occur but may not be detected and corrected or
prevented by the entity's internal control mechanism. Example,control risk assessment may be higher in
an entity where separation of duties is not well defined.
DR is the probability that the audit procedures may fail to detect existence of a material error or fraud.
While CR depends on the strength or weakness of the internal control procedures, DR is either due to
sampling error or human factors.