Business Risk
Business risk is the risk associated with the overall operations of a business entity. It’s the risk that the business managers might make incorrect decisions, or fail to anticipate future events and thus cause the business to be unprofitable or even fail. For instance, Fred invented a widget he thinks will be the next great consumer gadget. Fred convinces Mary to invest $100,000 in his widget business. Fred uses the money to manufacture his widgets and bring them to market. If sales are low, or even non-existent, then Mary has lost her $100,000 due to business risk. She and Fred thought that the widget would sell, when in reality, consumers did not like it and thus did not buy it. There are many factors that affect business risk. A major factor, as demonstrated in Fred and Mary’s case, is consumer tastes and preferences. Other factors are such things as supplier dependability, the competition’s activities, the overall economic climate, changes in government regulations, and lawsuits.The financial ratios that highlight a company’s business risk are contribution margin, operating leverage, financial leverage and total leverage. A company with a high amount of business risk should avoid acquiring extensive debt, because a sharp downturn in business could reduce revenue below the company’s ability to service its debt, and thus lead to bankruptcy. Companies with high business risk keep their operations very lean so they can get by when revenues are low. However, when revenues are high, they experience exceptionally large profits.
Fact checked by Jared EckerReviewed by Khadija KhartitFact checked by Jared EckerReviewed by Khadija Khartit
Running a business comes with many types of risk. Some hazards can destroy a company, while others can cause serious damage that is costly and time-consuming to repair. Despite the risks implicit in doing business, CEOs and risk management officers can anticipate and prepare, regardless of the size of their business.
Key Takeaways
- Some risks can destroy a business or cause serious damage that can be costly.
- Organizations should identify which risks pose a threat to their operations.
- A risk management consultant can recommend a strategy that includes staff training, safety checks, equipment and space maintenance, and insurance policies.
Facility Risks
Manufacturing plants, warehouses, and office buildings pose various risks for businesses and management. Organizations commonly implement the following safeguards:
- Employees should know the street address of the building to alert a 911 operator.
- Employees should know the location of all exits.
- Install fire alarms and smoke detectors.
- Install a sprinkler system to protect the physical plant, equipment, documents, and personnel.
- Hold fire drills and routine safety training sessions.
The Occupational Safety and Health Administration, under the U.S. Department of Labor, ensures that workers have safe working conditions. OSHA sets and enforces safety standards and provides training and assistance to companies and employees.
Hazardous Materials
Hazardous material risk is present where spills or accidents are possible and include substances like acid, gas, toxic fumes, toxic dust or filings, and poisonous liquids or waste. Fire department hazardous material units are prepared to handle these types of disasters. Employees should be properly equipped and trained to handle these materials safely.
Government agencies and local fire departments provide information to prevent these accidents. The U.S. Department of Transportation mandates companies and their employees who transport hazardous materials follow training requirements per federal law.
Location Risks
Among the location hazards facing a business are nearby fires, storm damage, floods, hurricanes or tornados, earthquakes, and other natural disasters. Employees should be familiar with the streets leading in and out of the neighborhood on all sides of the place of business. Liability or property and casualty insurance is often used to transfer the financial burden of location risks to a third party or a business insurance company.
Personnel Risks
Embezzlement, theft, and fraud may appear in the workplace. A system of double-signature requirements for checks, invoices, and payables verification can help prevent embezzlement and fraud. A thorough background check before hiring personnel can uncover previous offenses.
Illness, injury, and addictions can affect employees. To prevent loss of productivity, companies can train backup personnel to handle the work of critical employees when they are absent due to a health-related concern. Employees may need to seek treatment, counseling, and rehabilitation if necessary. Some insurance policies may provide partial coverage for the cost of treatment.
Management may make mistakes and pose risks to the company related to bias, racism, sexism, harassment, corruption, discrimination, pollutive actions, and carelessness about the environment. The U.S. Equal Employment Opportunity Commission is one resource that offers harassment prevention and respectful workplace training.
Technology Risks
Auxiliary gas-driven power generators are a reliable backup that provides electricity for lighting and other functions during outages. Organizations should furnish critical business systems with surge-protection devices to avoid the loss of documents and the destruction of equipment.
Cloud storage involves backing up data with sources like IBM Cloud Storage. Companies can establish offline and online data backup systems to protect critical documents.
Strategic Risks
Financial institutions such as banks or credit unions take on strategy risk when lending to consumers. Pharmaceutical companies are exposed to strategy risk through research and development for a new drug. Each of these strategy-related risks is inherent in an organization’s business objectives.
Companies exposed to substantial strategy risk can mitigate the potential for negative consequences by creating and maintaining infrastructures that support high-risk projects. A system established to control the financial hardship when a risky venture fails often includes diversification of current projects, healthy cash flow, or the ability to finance new projects affordably, and a comprehensive process to review and analyze potential ventures based on future return on investment.
Risk Assessment
Companies can rank the probability of risks after the risks have been identified. The first step is to establish a probability scale for risk assessment:
- Very likely to occur
- Some chance of occurring
- A small chance of occurring
- Unlikely to occur
Actuaries use prediction models to estimate risk levels. These prediction models are based on assumptions that aim to reflect real life and the need for insurance. Actuarial tables provide a statistical analysis of the probability of any risk occurring and the potential financial damage.
Insurance and Prevention
Many risks are insurable. Fire insurance and product liability insurance are common company policies. The risk of fraud or embezzlement where employees handle money or perform accounting duties is covered by specialized insurance companies that underwrite a cash bond to provide financial coverage. “Employee Dishonesty Insurance,” or a “fidelity bond,” offers protection against losses caused by an employee’s misconduct.
The extent of insurance coverage against injury depends on the nature of the business. A heavy manufacturing plant will require more extensive coverage for employees. Product liability insurance is also a necessity in this context. Hiring a risk management consultant may help prevent and manage risks.
Preventing risk requires employee training, background checks, safety checks, equipment maintenance, and maintenance of the physical premises. A single, accountable staff member with managerial authority should be appointed to handle risk management responsibilities. A risk management committee may also be formed.
Important
It is legal for an employer to ask questions about an employee’s background, or to require a background check. However, there are restrictions on obtaining medical and genetic
information.
When Should Risks Be Identified?
For startups and established businesses, the ability to identify risks is a key part of strategic business planning. Strategies to identify these risks rely on comprehensively analyzing a company’s business activities.
What Are the Benefits of Risk Management?
If and when a risk becomes a reality, a well-prepared business can minimize the impact on earnings, lost time and productivity, and impact on customers.
What Are the Ways That Organizations Handle Risk?
Most organizations face preventable, strategic, and external threats that can be managed through acceptance, transfer, reduction, or elimination. Training policies, safety programs, and insurance help companies choose how to handle risks.
The Bottom Line
While business risks abound and their consequences can be destructive, there are ways and means to prevent them, and minimize their damage, if and when they occur. Hiring a risk management consultant may be worthwhile when implementing a strategy.
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