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What is a Business Risk and How can it be identified?

Business risk is defined as the factors that will lower company’s profits or lead to its failure. Business risk can happen because of internal as well as external factors of company.

It is practically not possible for a company to completely shelter itself from any kind of risk. The only way is to reduce the overall risks associated with the business by creating a strong risk management strategy. The type of risk can vary from one company to another company on the basis of kind of industry, size of company and kind of operations.

These are the Types of Risks:-

1. Operational Risk– Any risk arising out of day-to-day company’s business activities will fall in operational risk. This risk is more related with the culture and working of the company. Operational risk is a human risk which arise due to human error. In areas where there is less human interaction, the chances of operational risk are lower. Data Breach is one of the examples of Operational Risk.

2. Strategic Risk– It is a risk related with failed business decisions. To get business goals, companies face downfalls. Strategic risk can also arise externally because of market demand and the environment in which a product/ service has to compete in the market.

3. Reputational Risk– As the name indicates this risk associated with name or entity of the business. Reputational Risk are mostly related with the actions or inactions of the company’s higher authorities, company’s employee or any associates of the company. The biggest fear of this risk is that their outcome cannot be easily measured. Reputational damage can be in negative publicity and negative perception of the company because of any unpredictable event and many more. It can fly billions of dollars in market capitalization and inflict sweeping changes to company’s leadership. The huge drawback with reputational risk is that it’s unpredictable.

Some companies use the approach of Crisis Management instead of Risk Management, which is having a reactive approach to limit the damage instead of proactive approach to not let the damage occur in the first place. However, like other Risks, it is compulsory to quantify Reputational Risk too.

4. Financial Risk– This risk is associated with finance handling. It will also include risks like liquidity & credit risks and many more. Companies cannot only face the possibility of default on debt they undertake but may also experience failure in an undertaking which causes a financial burden on the business. In some places, financial risk overlaps with operational risk too.

Financial risk can arise because of many macroeconomic forces like changes to the market interest rate, and the possibility of default by sectors or large corporations. When company takes any type of debt to grow this creates a financial risk to business and to investors or stakeholders invested in the company also.

Financial Risk like any other risk is inevitable, which means, it is not instinctively good or bad up to a certain degree. Calculating a business risk can lead to better investment decisions.

There are many tools to calculate financial risk:-

  1. Fundamental analysis– Process of measuring a security’s intrinsic value by evaluating all aspects of the underlying business including the assets and its earnings of the firm.
  2. Technical analysis– Process of evaluating securities by statistics and looks at historical returns, trade volume, share prices, and other performance data.
  3. Quantitative analysis– Evaluation of the company’s historical performance using specific financial ratio calculations.

5. Legal & Compliance Risk– Any new legislation regulations that comes up can decrease or increase your legal risk.

Like any other risk, legal risk is inevitable too. It is essential for companies to comply with the law of the land to avoid any potential penalty or any other adverse effect on the company. With increase in a legal risk of company, reputational and financial risk also effected.

Most common causes of a company’s exposure to legal risks include fraudulent practices, environmental issues, privacy & data security breaches and many more.

To deal with legal risks companies go in the process of Compliance Risk Management. While undertaking such process it is mandatory to look at the regulatory landscape of the industry and the state, however without ignoring the internal processes and procedures set out in company policies. Because a compliance risk is not codified to one department or one level of the company, it needs a collective approach for successful compliance management.

6. Political Risk (Franchise Risk) – This kind of risk can vary from changes in the kind of government of country or at a particular time area being politically unstable. This can also include political instability in another country where company’s Head Office or Manufacturing Unit is located.

Business Model Risk also fall in this category. In extreme forms also known as disruption risk. But unlike any other form of risk, this has a broaden impact on any business. It is dependent on all aspects of a business model namely- Value Proposition, SCM, Customer Segment, Product Identification/ Service Classification, Operations and Competitors etc. This included external and internal factors too.

How To Make A Risk Management Plan

  • Preparing a risk management plan is an essential task to ensure that company does not go in the state where any kind of risk hits. Preparation of a risk management plan is a tough work and needs an extensive study of the whole functioning of not only the company, but the industry as well as the market conditions.
  • Most companies go for professional help for building risk management plans. However, it is mandatory that the company’s directors and senior officials also spend sufficient time with the experts to ensure that there are no loopholes in their risk management plan. Risk Management plan is a tailor-made document for the specific company, it is very important that company’s directors and higher management takes more time in creating an effective and functional plan.
  • An effective risk management plan can protect the company from huge financial losses and most of the time from public embarrassment.

Below are some points on how to create an effective risk management plan.

  • Identify all risk that may arise in the business plan.
  • Collect the available data and assess level of risk on the company. Ensure that company has the required resources to fight.
  • Ensure to take up the riskiest acts first. Thereby going down to the least risky.
  • Take actions cut back the risk on its roof itself before it could grow. Prepare for action plan for risk mitigation.
  • Document every case for propose of evidences, notes, future references in case of similar situations.
  • Use and keep tested ideas handy for risks of repetitive nature. Derive step by step methodology to be used.