Business owners often learn the hard way that in today’s global operating environment, the potential for risks to occur is increasing dramatically.It only takes one trial by fire for owners to recognise the importance of basing their decisions on both the risks and rewards it will bring.
To reduce the chance of loss, owners must maintain focus on potential business risks. Suffering a loss can drastically affect any and all efforts to increase profitability.
Therefore, steps must be taken to prevent these risks occurring and to protect the company’s both operational and financial well being. To do this, each business risk must be identified, as well as it’s origin and characteristics.
The Origins of Business Risk
Business risk is assumed – the possibility that actual returns will result in more or less than expected returns – as soon as a company begins.
The type and long term severity of each risk varies, depending on the company’s operations and the industry they operate within. For example, new market contenders, changing consumer demand and economic downturns are risks to companies within the media and entertainment industry. On the other hand, a shortage of skilled labor and access to infrastructure may affect companies operating in the mining industry.
Financial risk impacts both your company’s cash flow and income. They can also affect the shareholder wealth as investors may value your business by discounting its projected cash flows. There are many different types of financial risks.
Firstly, there is liquidity risk. This affects a company’s retained earnings and capital, if a business is unable to meet its current liabilities without suffering major financial losses. Financial risk can also be market risk which includes changes to commodity prices, credit spreads, interest rates or equity prices.
Thirdly, there is company reporting risk, where there is a possibility that a company report, accounting, tax or regulatory data is inaccurate or reported in an untimely manner. Other financial risks include credit risk – the inability to meet financial obligations when due – and capital structure risk – a company’s debt to equity ratio, which is determined by the way a business finances their operations.
The strategic risk for your company is determined by it’s operating environment, business functions and investor communications. The operating environmental risk is determined by the markets in which your business buys and sells goods/services.
An environmental risk also depends on the government regulations and compliance requirements that govern the operations and markers of your company. In turn, unfavourable changes in the supply or demand of both products and/or services also affect a company’s strategic risk, as do the competitors that vie for the sales and supplied in your market.
Operational risks (process and innovation risk) concern the internal activities of your company. Process risk relates to your resources, including employees, equipment, materials and business processes, that affect the continuing operations of the company and support production processes.
On the other hand, innovation risk depends on the success or failure of both performance improvements or business process upgrades. It also relates to the degree a company’s investment is rational in product improvements and its approach to the development of new products.
During the decision making process, business owners consider a number of things including potential risks. In order to ensure a business doesn’t suffer loss that puts operations in doubt, business risk must be properly managed. The first step is to identify and classify these risks, including strategic, financial and operational risks.