BUSINESS

RISK

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Risk & types of risk

Risk measure likely fluctuation in return how much will Return vary from E(R) how likely is actual Return to vary from E(R) measured by variance (s2) standard deviation (s) Types of risk Systematic risk : it is due to risk factors that affect the entire market such as investment policy changes, foreign investment policy, change in taxation clauses, threats and measures etc. Systematic risk cannot be diversified. Unsystematic risk :is due to factors specific to an industry or a company like labor unions, product category, research and development, pricing, marketing strategy etc. Unsystematic risk can be diversified Pure Risk: Threat of loss with no opportunity for gain Economic Risk Occurs when there is likelihood of financial loss it May result from changes in overall business conditions Example: If a competitor offers more features, other businesses need to change their product or face losses. Other Economic Risks are Property Risk, Liability Risk etc Natural Risk The possibility of a catastrophe caused by natural elements that can cause damage or loss of property. Examples include floods, fires, lightning, earthquakes, etc.

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What is business risk!

Threats to achieving organizations business objectives A business risk is a circumstance or factor that may have a negative impact on the operation or profitability of a given company. Sometimes referred to as company risk a business risk can be the result of internal conditions, as well as some external factors that may be evident in the wider business community

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EXAMPLES OF BUSINESS RISK

Shortsighted goals Ineffective processes Financial fraud Failure to comply with government
regulations Tarnishing reputation

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BUSINESS RISK INCREASES AS ENVIRONMENT CHANGES

competition Pressure for increased productivity, while
reducing costs Powerful new technologies

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BUSINESS RISK CAN BE CATEGORIZED

Financial- protecting monetary funds Strategic- goals of the organization Operational- processes that operationalize
goals Compliance- laws and regulations Reputational- public image
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Measuring business risk!!

Business risk can be calculated through standard deviation of ROIC (return on invested capital) ROIC. it find the risk on standalone bases. ROIC combines degree of uncertainty of operating profit and its capital (investment) required by a firm ROIC= NOPAT/CAPITAL ROIC=EBIT(1-T)/CAPITAL
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Factors That Influence Business Risk

Uncertainty about demand (unit sales). The more stable the
demand for a firm products other things remain constant, lower the business risk
markets are exposed to more business risk material)

Sale price variability: firms whose products are sold in highly volatile Uncertainty about input costs. If firm Input cost business risk (raw Ability to adjust output price for change in input costs Develop new products in a timely, cost-efficient manner (high
technology, drugs)

Degree of operating leverage (DOL). If the extent to use fixed asset Foreign risk exposure: the firms that generate high percentage of their
earnings are subject to declines due to exchange rate fluctuations
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operating leverage, and its affect on business risk?

Operating leverage is the use of fixed costs
rather than variable costs e.g. salary of skilled employee (engineer, lawyer etc) The higher the proportion of fixed costs within a firms overall cost structure, the greater the operating leverage. Relative small change in sales results in a large change in EBIT.

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 Higher operating leverage leads to

more business risk, because a small sales decline causes a larger profit decline. QBE=FC/P-VC
$ Rev. TC $

Rev.

} Profit
TC FC QBE Sales

FC
QBE Sales

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 Risk Management

the systematic process of managing risk to achieve your business objectives Risk cannot be totally eliminated, but it can be reduced and managed Methods for handling risks Risk Avoidance her the chance of loss is reduced to zero. For example, flood losses can be avoided by not building a new plant in a flood plain RISK PREVENTION Risk prevention refers to measures that reduce the frequency of a particular loss. Risk Reduction risk reduction refers to measures that reduce the severity of a loss after if occurs examples include installation of an automatic sprinkler system Risk financing risk financing refers to techniques that provide for the funding of losses after they occur Risk Transfer Insurance provides a way to transfer a risk of loss to an insurance company.

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Questions, Discussions, .

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