This post discusses business risk and business risk management. In this post, you will understand the meaning of business risk and the management of business risks.

WHAT IS RISK?

Risk is the uncertainty of financial loss. A risk is anything that may affect the achievement of an organisation’s objectives. It is the uncertainty that surrounds future events and outcomes. Risk is the expression of the likelihood and impact of an event with the potential to influence the achievement of an organisation’s objectives. Risk (uncertainty) may affect the accomplishment of the goals. Hence, it benefits enterprises or businesses to manage their risk exposures.

BUSINESS RISK

Business risk is a broad category. Business risk refers to a threat to the company’s ability to achieve its objectives and financial goals. It applies to any event or circumstance that has the potential to prevent you from achieving business goals or objectives. In business, risk means that a company’s plans may turn out differently than initially planned or may need to meet its target or achieve its goals. 

Business risk can be internal (e.g., a firm’s strategy) or external (e.g., the global economy). All types of risks should not be managed or treated similarly. A business organisation should understand the kind of risk it faces internally (within the firm) and externally (outside the firm). Risk evaluation enables a firm to determine the importance of risks to the business and decide to accept a specific risk or take action to prevent or minimise the risk. A company should not manage or treat all risks in the same way.

CAUSES OF BUSINESS RISKS

There are three causes of business risk:

1. Natural causes: Natural causes of risk include flooding, earthquakes, cyclones, and other natural disasters that can lead to the loss of lives and property. 

2. Human causes: Human causes of risk refer to negligence at work, strikes, work stoppages, and mismanagement.

3. Economic causes: Economic causes involve rising prices of raw materials or labour costs and rising interest rates. An interest rate is an amount a lender charges a borrower for any form of debt given, generally expressed as a percentage of the principal for borrowing and competition.

How to Identify Business Risks?

Risks are inherent to every environment and business. Risk management encompasses identifying, analysing, and responding to risk factors that form part of the life of a business. The first step in managing risk is identifying the risks to develop a risk management strategy. Here are tips on how to identify business risks. See the post on ‘26 ways to identify risk in an organisation‘.

BUSINESS OR ENTERPRISE RISK MANAGEMENT (ERM)

Businesses must manage their risks effectively to ensure good performance and growth. Business or enterprise risk management is a crucial business practice that helps businesses to identify, evaluate, track, and mitigate potential risks that may impact their operations and activities. Risk management is often practised by businesses of all sizes, directly or indirectly. Though, some firms need to manage their risk more effectively. Small firms usually manage their risks informally, but large firms should adopt a risk management process to suit their operations.

BENEFITS OF ENTERPRISE RISK MANAGEMENT

Enterprise risk management process helps businesses to achieve their objectives. Enterprise risk management also enables a business to: 

1. Make informed decisions, plan, and prioritise,

2. Allocate capital and resources appropriately, 

3. Prevent wastage of time and effort in fire-fighting and addressing potential problems,

4. Discover opportunities, 

5. Reduce business liability, 

6. Foresee what may go wrong, pre-empt, prevent, or react promptly to risks, and 

7. Improve outcomes for business and professional performance.

ENTERPRISE RISK MANAGEMENT (ERM) FRAMEWORK

ERM promotes a holistic method of managing operational and strategic risks across the organisation. The ERM framework is essential regardless of the institution’s size or how it wishes to categorise its risks. ERM framework will assist companies’ management and boards of directors in managing their organisations’ risks. Sound ERM framework must address a firm’s critical risk management questions.

The strategic plan for ERM includes four enterprise-wide strategic initiatives:

1. Mitigation,

2. Preparedness,

3. Prompt emergency response, and

4. Quick business activity resumption and recovery.

TYPES OF BUSINESS RISKS

Business risk refers to a threat to the company’s ability to achieve its financial goals. Business risk can be internal (e.g., a firm’s strategy) or external (e.g., the global economy). Businesses are susceptible to several risks including:

1. Economic Risk: The economy constantly changes as the markets fluctuate. It is important to watch changes and trends to identify and plan for an economic downturn. Some positive changes are suitable for the economy, which leads to booming purchase environments, while adverse events can reduce sales. 

2. Financial Risk: Financial risk refers to a business’ ability to manage its debt and fulfil its financial obligations. This type of risk typically arises due to instabilities, losses in the financial market or movements in stock prices, currencies, and interest rates. The more debt a company has, the higher its financial risk. 

3. Regulatory risk: Regulatory Risk is the risk that a change in laws and regulation will significantly impact an institution. A change in laws or statutes enacted by a governmental or regulatory body can dramatically increase the costs of conducting a business, decrease the attractiveness of an investment, or change the competitive landscape.

4. Compliance risk:  Compliance risk involves companies having to comply with new rules set by the government or a regulatory body. For example, there may be a new minimum wage that must be implemented immediately. 

5. Security and Fraud Risk: As more customers use online and mobile channels to share personal data, there are also more significant opportunities for hacking. This risk impacts trust and reputation, and a company is also financially liable for data breaches or fraud. 

6. Reputational risk: Reputational risk is the potential for negative publicity, public perception, or uncontrollable events to impact a firm’s reputation, affecting its revenue negatively. 

7. Operational risk: Operational risk is the possibility of business operations failing due to inefficiencies or breakdowns in internal processes, people, and systems. Operational risk occurs within the business’ system or processes. Human error and external events are a few familiar sources of such risk. 

8. Strategic risk: Strategic risk is the potential impact of strategic decisions or a defective or inappropriate strategy. Strategic risk is associated with future or long-term planning – e.g., entering new markets and expanding existing services. Strategic risk constitutes a need for more responsiveness to industry or sectoral changes. 

8. Political risk: Political risk is a type of risk faced by investors, corporations, and governments that political decisions, events, or conditions will significantly affect the profitability of a business actor, or the expected value of a given economic action. Political risk is associated with changes within a nation’s policies, business laws, or investment regulations. 

9. Liquidity risk: Liquidity risk occurs when an individual investor, business, or financial institution cannot meet its short-term debt obligations. Liquidity is the ability of a firm, company, or individual to pay its debts without suffering catastrophic losses. 

10. Country risk: Multinational or international firms are susceptible to country risk. Country risk constitutes uncertainty associated with investing in a particular country and, more specifically, the degree to which that uncertainty could lead to investor losses.Country risk is when economic, social, and political conditions and events in a foreign country will affect a bank’s current or projected financial situation or resilience. 

11. Information and technology (IT) risks: IT risk is any threat to a firm’s data, critical systems, and processes. It is the risk associated with the use, ownership, operation, involvement, influence, and adoption of IT within an organisation. 

12. Cybersecurity risk: Cybersecurity refers to the technologies, processes and practices designed to protect an organisation’s intellectual property, customer data and other sensitive information from unauthorised access by cybercriminals. The frequency and severity of cybercrime are on the rise, and there is a significant need for improved cybersecurity risk management as part of every organisation’s enterprise risk profile. Hence, the need for effective cybersecurity risk management.

13. Investment risk: Investment risk is the probability or likelihood of occurrence of losses relative to the expected return on any particular investment. Generally, a certain level of risk is involved in all kinds of investments. Management of risk is essential to ensure a sound investment strategy. 

14. Credit risks: Financial institutions, including banks, mortgage, and finance firms, are susceptible to credit risks. Credit risk is the probability of loss due to a borrower’s failure to pay for any debt. Credit risk is the possibility that a contractual party will fail to meet its obligations under the agreed terms. 

15. Counterparty risks: Banks, hire purchase, mortgage, and finance firms are susceptible to counterparty risk. Counterparty risk is the probability that the other party in an investment, credit, or trading transaction may not fulfil its part of the deal and may default on the contractual obligations. 

16. Foreign exchange: Financial institutions, manufacturers, and importers are susceptible to foreign exchange risks. Foreign exchange risk (also known as currency risk, FX risk and exchange-rate risk) refers to the losses an international financial transaction may incur due to currency fluctuations. It arises from the change in the price of one currency to another. 

17. Emerging risks: Emerging risks are new or familiar risks that become apparent in new or unfamiliar conditions. Novel manifestations of risk include entirely new risk types that have not existed previously. Their sources can be natural or human, and often are both.

STRATEGIES FOR MANAGING BUSINESS RISKS

To determine a business’ most effective risk mitigation strategy, the company must first identify its risk exposures, analyse, and evaluate their potential likelihood and impact. When you fully understand all the possible risks and their severity, you can begin to treat them. The most common strategies for treating business risks include:

1. Risk avoidance, 

2. Risk reduction, 

3. Risk transfer, 

4. Risk retention, and

5. Risk sharing.

INTERNAL CONTROLS FOR RISK PREVENTION

Managing and reducing risk involves putting processes, methods, and tools in place to deal with the outcomes of events identified as threats to the business. Adequate internal controls are necessary to mitigate different types of risks to a business. In this regard, there are two categories of control:

1. Preventive controls – avoid risk before it occurs; and 

2. Detective controls – helps to find the source of the problems after the occurrence.

See the video on Business Risk & the Management of Business Risks: https://youtu.be/q4MaAHDrZRY