Competition has become more dynamic in recent years, increasing the business risk for many companies. The business environment is rapidly changing. And it causes some challenges and problems.
What is the business risk
Business risk is the uncertainty that a company faces and can cause business loss or failure. Uncertainty makes it difficult for companies to reach targets.
Some risks may be within the company’s control. In a sense, the company can still manage it. However, some risks are beyond the company’s control. They can only adapt and minimize their impact on the company.
Types of business risk
In a general classification, business risks can be in the form of:
- Strategic risk
- Operational risk
- Compliance risk
- Financial risk
Strategic risk
Companies need to develop value creation strategies to achieve a competitive advantage. They have competitiveness when they can adopt the right strategy and implement it successfully.
At times, their strategy is no better than competitors. That is bad for business. Or, the company’s strategy is good but weak in its execution, for example, due to low commitment from executives and employees. Once again, it harms the company.
For example, the target market tends to be price-conscious. However, companies implement differentiation strategies and try to change consumers’ perceptions that their products are better. Instead of getting good sales, their products don’t sell.
Strategic risk has the most significant implications in achieving company goals. If the company’s strategy is less effective, the disadvantage will emerge.
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Operational risk
This risk arises from the company’s daily activities. That may be due to employee errors, production system failures, and inadequate internal procedures. Sources of risk can also come from external, but affect the company’s operations.
Some examples of operational risks are:
- Contract dispute
- Technology failure
- Human error
- System Damage
Compliance risk
Compliance risk arises due to non-compliance with laws or other regulations. When violating, the company might get sanctions or damage its credibility. The impact of compliance risk is significant for some highly regulated industries such as banks and insurance.
Financial risk
Financial risk is the uncertainty associated with managing financial companies. One of them is the risk due to cash flow mismatch.
Companies need to invest, for example, new production facilities, because with which the business develops. They can use various capital options, from internal sources (retained earnings), debt securities, or equity. Inadequate cash flow often arises. The company has spent money on projects, but that doesn’t immediately make more money quickly.
Business risk sources
Uncertainty can arise from internal or external. Internal risks occur from within the organization. It occurs during regular operation and comes from a combination of physical, technical, and human factors.
This type of internal risk can be controlled and, in some cases, can be avoided or reduced. Negligence at work, obsolete production machinery, and strikes are two examples of internal risk sources.
External risks come from outside the company. The company has no control over it. They can only adapt and reduce their exposure to the company.
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External risks can arise due to changes in economic, political, regulatory, and social demographic conditions. Changes in the competitive environment are also a source of external risk.
Some examples of external risks are:
- Natural disasters, pandemics and climate change
- Technology disruption
- Unfavorable economic conditions (for instance recession, hyperinflation, or high-interest rates)
- Geopolitical risk
- Changes to regulations
- Changes in consumer preferences and tastes
- Increasingly intense competition
Impact on the company
Business risk causes companies not to be able to meet targets or achieve company goals. They are not able to provide adequate returns to investors. Uncertainty can also result in business failure and even bankruptcy.
Risks have a more significant impact when a company has high leverage. That makes companies difficult to get cheap funding. Investors see the company has a high risk of default.
The combination of business risk and high leverage makes it difficult for a company to fulfill its financial obligations at any time. When revenue falls, they can’t pay back the debt, and it can lead to bankruptcy.
