Business risk refers to unexpected or unanticipated factors or conditions in the company’s environment which negatively affect the company's performance. Business risks, by their nature, are unexpected for which the companies evaluate little to no anticipations.
They are powerful factors that drive changes in the marketplace and the operational flow of the companies.
Did You Know? Business risk cannot be eliminated for any organisation but can only be assessed and managed.
Meaning of Business Risk
Business risk can be defined as the possibility of a commercial business making inadequate profits, including losses due to uncertainties in the company’s external and internal environment.
There could be an end number of examples of business risks like a major supplier of the company going bankrupt posing the risk of operational shutdown, same way change in taste and preferences of the customers could badly hamper the revenue of the company. It is a matter of fact that businesses operate in an uncertain and complex environment sensitive to changes and development, possessing the risk of hampering the organisation's operation.
Like a hike in interest rates may generally increase the cost of borrowing funds, a company relying on too much debt for funding its operation may face the risk of huge interest costs and reduced profitability.
Types of Business Risk
Depending on internal and external environmental factors, business risk could be dividend on the following types-
Strategic risk refers to the risk associated with the strategic intent and the business model of an organization. When a company struggles to operate with its business models, it is the strategic risk the business is ineffective with. It comes from poor implementation of the formulated strategy. A company will succeed only if the strategy formulation is sound and implementation is excellent.
For example - Walmart, a US retail chain has strategically positioned itself as a low-cost provider and decided to cut costs to offer the best prices. This becomes a strategic risk for Walmart.
Often businesses are regulated by the government regulator. For example - the financial industry participants are regulated by the frameworks set by the Securities Exchange Board of India (SEBI). This poses the risk that if such participants do not comply with the regulations, they will be penalised or often forced to curtail their operations. This poses a risk for the companies.
Operations of an organisation are the core activity to profitability. The risk arises within the organisation, especially when the day-to-day operations of the company fail to perform as expected. For example - The multi-national bank HSBC faced a high degree of operational risk in 2012, incurring a huge penalty from the US Department of Justice when its internal anti-money laundering team failed to adequately stop the money laundering in Mexico.
A company having too much debt for financing its operations and expansion plans often expose itself to financial risk. It is ideal for a profitable company to leverage its operation not exceeding two times the equity in the total capital structure of the company; otherwise, the company is considered financially risky. If a company is not highly liquid, then the debt will eventually pile up on account of default resulting in the company curtailing a major portion of its operation to save cash and may be required to sell its assets to pay off the debts. In a worse situation, the company was forced to go through liquidation, which was not ideal for any of the stakeholders.
It is quite evident in the case of Kingfisher airlines that it was a high risk in terms of its financing structure, eventually forcing the company to liquidate.
It is quite often, companies position themselves in the market through a desired image and destination. However, not everyone is able to hold on to its images owing to uncertainties in the environment in which they operate.
For example - Apple Inc. positioned its iPhone as a user-friendly smartphone with a premium look and feel. Thus, Apple is required to maintain the same image with every iPhone they lunch.
How to Assess the Bussiness Risk?
Business risk cannot be measured or quantified into numbers. At best, it could be identified and assessed as high, low, or medium. It is important that businesses should assess their business risks and plan their strategy in light of it. Also, it’s important that a business consider the factors in its internal and external environment that threaten its operation. To identify business risks, a business manager should ask the following questions -
- What could go wrong in this process?
- How could we fail?
- What are we doing that not adding up?
- Which asset do we need to protect?
- Do we have enough liquid assets to pay our debt obligations?
- What are the areas where er have inadequate controls?
Thus through constant scanning and analysis of business processes and their environment, one could identify and assess the business risk areas and act upon them to minimise the risk of something could go wrong.
Here is the already established framework to assess business risk -
The internal environment of a company usually is a very complex set of operation and management processes. Here are a few frameworks to access the internal environment of a company.
SWOT stands for strength, weakness, opportunity, and threats. Strength is the inherent capabilities of an organisation. Weakness is the inherent incompetence of an organisation. Opportunity is the unanticipated favourable development in the environment of an organisation. Threats are unfavourable development in the environment of an organisation. A company could use its strength to build upon opportunities and minimise threats in its environment.
Igor Ansoff’s Matrix
The framework helps businesses in strategic decision-making. It is a useful tool to decide the product and market growth strategy. The framework suggests four growth strategies namely, product development, market penetration, market development, and diversification.
The external environment of an organisation is also turbulent and complex. It includes the customers, suppliers, government, and regulators. They all, individually or in the collection, may hamper the growth prospect of an organisation. Here are a few frameworks for external environment analysis -
PESTEL stands for political, environmental, social, technological, environmental, and legal. The framework helps businesses identify different environmental constituents and their probable impact on the organisation.
Porter’s Five Forces Model
An analysis tool that helps conceptualise the attractiveness of a particular industry, measured against factors like barriers to entry, customer and supplier bargaining power, and the threat of substitute products or services.
How do We Reduce Business Risk?
A Company is made of its different processes and the resources following through it. Firstly, managers should identify bottleneck processes or processes that are not part of the customer value chain in the organisation. Then, those identified processes should be reduced or removed, or at best, focus should be made on core value chain processes to minimise the business risk.
Secondly, controls should be designed for resource allocations or management of resources. Companies could identify the processes where IT controls could be designed so that reducing the chances of clerical or human errors.
Also, resources could be linked to the customer value chain so that wastage may be minimised. Lastly, a team of experts could be appointed in the organisation to specifically look for bottleneck processes and check on the implementation of controls. For example - Big corporations usually appoint an Internal control team to look into the effective design and implementation of internal controls in the organisation.
The organisation, whether profit oriented or not, irrespective of their nature and size, face uncertainty in their working environments. This phenomenon is termed business risk.
Businesses identify them and assess them as they follow through the path of success, and they use their strength to minimise them as well. However, it is not quite possible to avoid business risk because of uncertainty. Thus, businesses follow a blend of strategies to minimize the unanticipated development in the environment that poses a risk to the operation of the organisation.
So far, we have discussed a lot about business risk, its components, types, factors, and how to identify and assess one. Hope you enjoyed reading it through.
Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.