Types of Business Risks
List of business risks you must beware of.
Before we start discussing about business risks, it is important we understand what risk is all about. The word ‘risk’ applies to almost everything we do.
Therefore, it is not restricted to business alone. What is risk? Risk is the probability that things will not work out as planned. That is, the likelihood for you not to achieve your desired results. So, if we should apply this to business, we now have what can be called business risks.
What is business risk?
Going by the definition of risk given above, we can say that business risk is the likelihood that the owner of a business may not achieve return on his investments. The primary objective of any profit oriented organization is to make profits. Business risk is the probability that the business will be unprofitable. That is why you hear people saying that starting a business is risky. Of course, starting a business involves risk because there is no any guaranty that the business will succeed. No matter the type of business you do, you will definitely be exposed to some business risks. The level of business risks an organization faces may vary from industry to industry. There are certain business risks that are peculiar to specific business or industry. These types of business risks are called unsystematic risks. However, there are other business risks that are general. They apply to every business regardless of which industry a business belong. This type of risk is called systematic risks. Examples of this are natural disasters and general economic recession. However, apart from these two broad classifications of business risks, we shall be looking at the five major types of business risks that entrepreneurs usually face.
Types of business risks
The major types of business risks are listed below:
- Strategic risk
- Compliance risk
- Financial risk
- Operation risk
- Reputation risk
Strategic risk
Every business requires a strategic positioning in the market place for it to succeed. Before a business is established, a lot of efforts must have been put into business planning so as to ensure that the business objectives would be achieved. Because planning involves projecting into the future, no one can accurately predict what will happen in the future. Therefore, certain business decisions have to be made based on some assumptions. Any change in these assumptions will most likely affect the business negatively. This is strategic risk. In most cases, you don’t have control over strategic risks because they are external. Examples of strategic risks are risks associated with technological change, new entrants into the market and change of customers’ preferences. All these can make a business not to achieve its objectives. In order to avoid the total collapse of the business, the management may need to quickly adapt or change its business model.
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Compliance Risk
Every business is expected to comply with laws and regulations. There are some laws and regulations that will apply to all businesses in general while some may only apply to a specific industry. Whether general or specific, any change in these laws may adversely affect a business. Need to comply with new or additional laws and regulations may arise as a result of change in laws and regulations of a particular country where a business operates. It can also be caused as a result of expansion into a new market. The laws in the new market may not be the same as the laws that exist in the existing market. For example, a business in United State of America that decides to open a new branch in India or Nigeria will be faced with compliance risk. Laws such as company laws, accounting regulations and minimum wage laws in the two countries are not the same. Apart from a business expanding into a new market, a business can also decide to expand its product line within the same market. The new product may require compliance to a particular law because of its peculiarity especially if the product is highly regulated.
Financial risk
People talk more of financial risk than any of the other business risks. With all the talks, you still discover that only few people know what financial risk entails. I may not be able to give you a full download of financial risk. Nevertheless, I will give a highlight of the elements of financial risk. Financial risk includes the following:
- Cash flow problem: You will be faced with liquidity challenge if you pay out more than you receive. Your credit policy and the credit terms you enjoy from suppliers impact greatly on the liquidity of your business.
- Loss of customer: If you are mono customer type of business or you depend so much on a particular customer, this poses a risk to your business. If such customer decides not to buy from you anyone, this can crumble your entire business.
- Too much debt: If your company is highly geared, that is, you depend too much on debt financing; it becomes difficult for you to access additional loans. Also, you will be paying too much interest to the point that the interests can swallow up your profits. A profitable business may turn unprofitable by reason of high interest payments.
- Access to capital: If your business is growing fast while you lack access to capital, this can lead to over-trading. Growth is good but if you are unable to support the growth by injecting fresh capital into the business, it can lead to catastrophe.
- Forex: If your business involves import and export, adverse change in foreign exchange rates constitutes a financial risk
- Pricing: In a very competitive market, you may not be able to increase your price arbitrarily. No matter the situation, your price should be able to cover your costs. Any business you do where your price cannot cover the costs and your overheads, such business will cause you losses.
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Operational Risk
Operational risk is internal. It is the effects of how you conduct your business. Just like financial risk, let’s break down operational risk into smaller elements:
- People: How do you recruit? What will be the effects of recruiting or putting a wrong person in a sensitive position? What happens to your business if your key staff should leave?
- Process: What will be the impact of any control lapses in your process/business?
- Production: Do you depend on a particular supplier for your raw materials? What impact can this have on your production in case of disappointment? Having a buffer stock may help you salvage the situation.
- IT: If your website is down, what impact can this have on your business? Will customers still be able to place orders? If your server crashes, do you have adequate back up systems? What is the possibility of your system being hacked and what will be the impact?
Reputational risk
The importance of reputation management in this social media age cannot be over-emphasised. Bad news concerning a business can travel fast round the world within a minute. What damage can reputational risk do your business? How can you prevent it? Assuming you are faced with reputational risk, do you have any system in place as damage control? It is difficult to build a brand but it does not take time to damage it. Such damage can come from competitors or any aggrieved employee.
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Business risks are always there but every business is expected to be proactive in managing them so that the business will not be unnecessarily exposed. Therefore it is important for every business owner to carry out the risk assessment of his business. This will help in the identification of business risks that may likely affect his business thereby taking proactive measure.