Business risk is common in among all business types, thus the importance of effective risk management cannot be overstated. Business risk affects a business's ability to operate properly and succeed financially. Therefore, understanding business risk is essential for all types of business managers. Let's take a closer look.

Business Risk Definition

Avoiding risk is an impossible task for businesses, but controlling and properly managing risk is achievable. Before we continue with this, it is important that we understand the term 'business risk'.

Forces that create business risk can come from internal sources, such as a poor management structure, bad publicity, theft, or the loss of talented employees. External forces may also be at play, such as the increasing prices of raw materials needed for production, increased competition, changes in customer demand, natural disasters, or changes to government or market policy.

Such forces make it impossible for businesses to avoid risk completely as they are unpredictable and can’t be controlled by the business. However, there are steps that can be taken by businesses in order to avoid these risks. An example is creating a risk management strategy.

Types of Risk in Business

There are five main types of risk in business:

• Strategic risk

• Operational risk

• Financial risk

• Compliance risk

• Reputation risk

Read along to understand each type with examples!

Fig. 1 - Types of business risk

1. Strategic risk

This risk arises when a previously laid-out business strategy becomes less effective or becomes no longer effective in a way that impacts business profit generation and growth, thus limiting businesses from reaching their set goals.

The risk can occur with changes in technology, the entrance of new competitors, changes in the business strategy of a direct competitor, or waning customer interest. To overcome this risk, businesses have to adapt their strategy.

2. Operational risk

This is a risk that arises inside the business, hence it can be termed an internal risk. Operational risk arises from the business's daily activity. This can include technical failure, inappropriate decision-making, or employee-related issues. However, it is important to note that sometimes operational risks may be due to external events such as natural disasters, power outages, etc.

3. Financial risk

Although all types of business risks have an impact on the business's finances, the financial type, as the term suggests, means the risk of sudden financial loss. This may arise due to changes in market conditions, providing credit to customers, and company debt.

An example of financial risk is selling your business's product on credit to 60 percent of your regular customers. This puts your business at great financial risk due to the fact that your customers may not or may not be able to pay for the services offered to them on credit.

4. Compliance risk

This type of business risk is common in highly regulated industries. Compliance risk arises from businesses not following industry operations regulations in their state. Compliance risk may also arise upon introduction of new business operation regulations, which can significantly affect a business's strategy.

5. Reputation risk

The reputation of a company is important. A company with a ruined reputation is at risk of losing public backing and customers, thus negatively impacting its brand loyalty.

Business Risk Causes

There are three main categories for business risk causes:

• Natural causes

• Human causes

• Economic causes

1. Natural causes

Risk may occur due to natural causes, or non-man-made factors that hamper the operations of a business. This may include natural disasters such as earthquakes, hurricanes, floods, etc. Businesses can defend against this risk by taking out insurance coverage to soften the effects of these disasters on their activities.

2. Human causes

Business risk due to human causes refers to human factors affecting the operations of a business. These factors may include employee issues, strikes, ineffective business management, poor decision-making, or changing consumer choices.

3. Economic causes

Economic factors may contribute to risk that limits businesses from reaching their financial goals. This may include increased cost of raw materials and labour, competition, market regulations, government policies, increasing interest rates, etc.

Accessing Business Risk

Business risks are generally unavoidable, hence the need for regular assessments. Businesses should aim to identify these risks and address them immediately. Assessing business risks can be divided into three steps:

While the goal of assessing business risk is to understand the risk, managing business risk's goal is to reduce the impact of that uncertainty. Below are ways to manage business risks:

• Prepare a business plan that outlines future possibilities of market changes and the steps the business can take to mitigate their effects.

• Invest in training of employees to deal with unsatisfied customers or natural disasters (e.g. flooding).

• Employ experts and consultants who have specialised knowledge on how to deal with business risks.

• Prioritise business risks on a scale of likely occurrence.

• Insure business assets.

• Diversification, also known as selling new products in different markets, might minimise the risk of competitors taking the business's market share.

• Create a risk management team for your business.

• Give a credit limit to high-risk customers.

• Provide quality assurance for your products to protect your reputation.

• Stay updated about the market, consumer interest, and your competitors and regulations, and embrace changes in the market.

Business risk is impossible to avoid, so understanding and constantly accessing the likelihood of potential risks is important in managing your risk. Risk, no matter the form taken, impacts the firm's financial goals and can cause a business to fail.

Table 1 - Business Risks Examples, StudySmarter