Economics project work: Risk and it’s role in business

Baltic State Technical University 
International Business & Communication Institute 
Master of Business Administration & Engineering (MBAE)

Economics project work: Risk and it’s role in business 

Executed by Babichev Maxim 
Scientific chief: Loukitchev P.M..

Saint-Petersburg 
2014 
 

Contents:

1. Introduction…………………………………………………….….3
2. What is risk?...................................……………………………..…4
3. Types of Business Risk……………………………………………7
4. Implications of Business Risk……………………………………..8
5. Usage of Business Risk……………………………………………9
6. Balancing risk and reward…………………………………………11
7. Risks in the real world……………………………………….…....12
8. Conclusion………………………………………………………...13
9. References…………………………………………………………14

 

 

Introduction

The proverb said: ’’ No risk, no gain.’’

 

The purpose of this project work is studying of risk and its role in business. I chose this subject because I consider it as one of the major aspects in firm management.

It’s not easy, because it is necessary to run in time for risks. You can win a lot, however you can lose everything. The interest is very high, because the prize is very big. The main role of risk is a chance of giving a huge profit, so it is balancing between risk and a reward.

I tried to tell about it below.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

What is risk?

Every business organisation involves some element of risk. Risk implies uncertainty of profits or danger of loss due to some unforeseen events in the future. An entrepreneur may encounter risks in every area or function of a business. For example:- in production, risks may arise due to irregular supply of raw materials, break down of machinery, labour unrest, etc; in marketing, risks may occur on account of price fluctuations, change in tastes and fashions, errors in sale forecasting, trade cycles, etc. In addition, there may be loss of assets of a firm due to fire, flood, earthquake, riots, war or political unrest which may cause unwanted interruptions in business operations. Thus, business risks may take place in a variety of forms. Though risks are universal, but all business enterprises do not face same type and degree of risks. They may vary according to the nature and size of a business.

These risks are inevitable in a business and cannot be eliminated completely but they can be controlled through proper preventive and corrective measures of risk management. The process of management of risk involves:

-Identification of the risks

-Evaluation of the risks

-Choice of the right method for handling of risks

-Evaluating the aftermath of the chosen method

 

Hence, an entrepreneur can face the risks effectively by anticipating their nature and causes and adopting appropriate techniques in order to minimise their negative consequences.

 

Also, gains in a business are inseparably linked to these inherent risks. In other words,' no risks, no gains' is a fundamental principle of a business. Hence, high profits of the big business houses are the rewards for successful management of the business risks by their entrepreneurs.

Business risks are of a diverse nature and arise due to innumerable factors. These risks may be broadly classified into two types, depending upon their place of origin.

Internal Risks are those risks which arise from the events taking place within the business enterprise. Such risks arise during the ordinary course of a business. These risks can be forecasted and the probability of their occurrence can be determined. Hence, they can be controlled by the entrepreneur to an appreciable extent.

The various internal factors giving rise to such risks are: 

Human factors are an important cause of internal risks. They may result from strikes and lock-outs by trade unions; negligence and dishonesty of an employee; accidents or deaths in the industry; incompetence of the manager or other important people in the organisation, etc. Also, failure of suppliers to supply the materials or goods on time or default in payment by debtors may adversely affect the business enterprise.

Technological factors are the unforeseen changes in the techniques of production or distribution. They may result in technological obsolescence and other business risks. For example, if there is some technological advancement which results in products of higher quality, then a firm which is using the traditional technique of production might face the risk of losing the market for its inferior quality product.

Physical factors are the factors which result in loss or damage to the property of the firm. They include the failure of machinery and equipment used in business; fire or theft in the industry; damages in transit of goods, etc. It also includes losses to the firm arising from the compensation paid by the firm to the third parties on account of intentional or unintentional damages caused to them.

External risks are those risks which arise due to the events occurring outside the business organisation. Such events are generally beyond the control of an entrepreneur. Hence, the resulting risks cannot be forecasted and the probability of their occurrence cannot be determined with accuracy.

The various external factors which may give rise to such risks are

Economic factors are the most important causes of external risks. They result from the changes in the prevailing market conditions. They may be in the form of changes in demand for the product, price fluctuations, changes in tastes and preferences of the consumers and changes in income, output or trade cycles. The conditions like increased competition for the product, inflationary tendency in the economy, rising unemployment as well as the fluctuations in world economy may also adversely affect the business enterprise. Such risks which are caused by changes in the economy are known as 'dynamic risks'. These risks are generally less predictable because they do not appear at regular intervals. Also, such risks may not necessarily result in losses to the firm because they may also contain an element of gain for the firm. For instance, due to market fluctuations, a well known product of a firm may either lose its demand or may occupy a larger market share.

Natural factors are the unforeseen natural calamities over which an entrepreneur has very little or no control. They result from events like earthquake, flood, famine, cyclone, lightening, tornado, etc. Such events may cause loss of life and property to the firm or they may spoil its goods. For example, Gujarat earthquake caused irreparable damage not only to the business enterprises but also adversely affected the whole economy of the State.

Political factors have an important influence on the functioning of a business, both in the long and short term. They result from political changes in a country like fall or change in the Government, communal violence or riots in the country, civil war as well as hostilities with the neighbouring countries. Besides, changes in Government policies and regulations may also affect the profitability and position of a enterprise. For instance, changes inindustrial policy and Trade policy annual announcement of the budgetamendments to various legislations, etc. may enhance or reduce the profits of a business enterprise.

Thus, business risk takes a variety of forms. In order to face such risks successfully, every businessman should understand the nature and causes of these risks as well as the various measures which must be taken in order to minimise them.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Types of Business Risk

 

Risk means that there is a chance that you won’t receive a return on your investment. It is an exposure to danger to your bottom line. When you are in business, you need to consider the kinds of events that could pose a risk to your business and take steps to mitigate them.

Strategic Risk

Strategic risks result directly from operating within a specific industry at a specific time. So shifts in consumer preferences or emerging technologies that make your product-line obsolete- eight-track, anyone - or other drastic market forces can put your company in danger. To counteract strategic risks, you’ll need to put measures in place to constantly solicit feedback so changes will be detected early.

Compliance Risk

Risks associated with compliance are those subject to legislative or bureaucratic rule and regulations, or those associated with best practices for investment purposes. These can include employee protection regulations like those imposed by the Occupational Safety and Health Administration (OSHA), or environmental concerns like those covered by the Environmental Protection Agency (EPA) or even state and local agencies.

Financial Risk

Direct financial risks have to do with how your business handles money. That is, which customers do you extend credit to and for how long? What is your debt load? Does most of your income come from one or two clients who might not be able to pay? Financial risks also take into account interest rates and if you do international business, foreign exchange rates.

Operational Risks

Operational risks result from internal failures. That is, your business’s internal processes, people or systems fail unexpectedly. Therefore, unlike a strategic risk or a financial risk, there is no return on operational risks. Operational risks can also result from unforeseen external events such as transportation systems breaking down, or a supplier failing to deliver goods.

Reputational Risk

Loss of a company’s reputation or community standing might result from product failures, lawsuits or negative publicity. Reputations take time to build but can be lost in a day. In this era of social networking, a negative Twitter posting by a customer can reduce earnings overnight. According to Matt McGee, a search engine optimization consultant, “One negative blog post or product review can spread online in a flash and change the direction of a company.”

Other Risks

Other risks are more difficult to categorize. They include risks from the environment, such as natural disasters. Difficulties in maintaining a trained staff that has up-to-date skills to operate your business is sometimes called employee risk management. Health and safety risks not covered by OSHA or state agencies fall into this category as do political and economic instability in countries you import from or export to.

[Dana Griffin,2008]

 

Implications of Business Risk

Business risk involves the possibility of financial and operational difficulties in the business environment. All businesses face some type of business risk. Small businesses are often more susceptible to business risk due to low capital or resource availability. Different types of business risk exist in the economic market. Each risk carries different implications for business owners to overcome. Business risk can also result from overall economic conditions. Changes in government monetary or fiscal policy often create riskier situations for businesses.

Strategic

Strategic business risk occurs from the amount of competition in the economic market. Increasing competition can create lower market share and fewer profits for a company. Business owners must also spend more time and money educating consumers on why their product is superior to a competitor’s product. Larger business organizations may be able to withstand higher amounts of competition than smaller business organizations. Small businesses can also struggle to maintain sufficient supply of economic resources. Economic resources are the raw materials, labor and other items companies need to produce goods or services.

Compliance

Small businesses must usually comply with various federal, state or local government regulations in the business environment. High government regulation can create more risk for small businesses. Business owners must constantly review regulations and develop business policies or procedures to ensure their company is in compliance. Small businesses may need to spend more capital and resources on changing operations to comply with new regulations. Business owners spending more capital to comply with government regulations have less money to increase production output or expand business operations.

 

Financial

Financial risk involves losing money from consumer sales or facing strict credit requirements. Business owners may sell inventory or other items to consumers at reduced prices in an attempt to make money to pay business expenses. Sales on account can also create difficult business situations. Not only must companies find ways to collect their money, but the company may also lose money from consumers who cannot pay future bills. Strict credit requirements may limit loan amounts, increase interest rates or create other unfavorable financing terms for businesses.

Operational

Operational business risk is the possibility of a company will face deteriorating situations in their production process. Inefficient facilities, broken equipment or theft represent a few operational business risks. Business owners with high operational risks face decreasing production output, low-quality consumer products and poor production efficiency. These situations can allow a competitor to step in and take away the company’s market share. Companies can also face increases and financial risks if they must continually spend money to repair or correct operational issues.

[Osmond Vitez,2009]

Usage of Business Risk

 

Business risk is just one kind of risk that investors must recognize.

 

Investing in companies' stocks is an inherently risky endeavor. However, investors can limit their exposure to losses by understanding the different kinds of risks that individual companies pose to their portfolios. Business risk is just one kind of risk that investors should understand before purchasing a stock. Studying business risk is no guarantee that investors will ultimately be able to avoid losing money, but it will help them make more informed decisions.

Risk Management

According to the Forbes' business publication, Investopedia, risk management is the process in which investors identify all of the potential risks in an investment portfolio and then evaluate the possible losses they could incur in the worst-case scenario. (After all, every day that the stock market is open, an investor could lose money if his investments drop in value.) Once investors determine their total possible losses, they must take action, such as selling investments or diversifying so risky investments are balanced with more stable ones. Alternatively, they can do nothing and accept the risks and potential losses. However, no matter what an investor's course of action, he must first understand risk.

Business Risk

Business risk is just one of the risks that investors must understand. Investopedia defines it as the risk that a company will not be able to pay for its operating expenses (its bills) because its cash flow is insufficient.

In Practice

In reality, every company faces risks from its structure and the external environment. Business risk is related to the way a company has structured itself. A company should have enough cash on its balance sheet to cover expenses, as well as some extra, needed for unforeseen expenses (perhaps lawsuits or natural disasters). If a company has too much debt or too many assets that it cannot translate into cash quickly, it has more business risk.

Calculating Business Risk

One of the best ways to determine business risk is to look at a company's balance sheet. Investors should know how much cash the business has coming in, how much is free cash and how much is already earmarked for things like dividend payments. Debt levels are also important, as is debt maturing in the near future. These payments require large amounts of cash, so investors should know whether current earnings can support a hefty payout or if companies will have to renegotiate their lines of credit, which can be costly as well. It can prove difficult for regular investors to sift through so much information, which is why Wall Street analysts provide reports detailing such information.

Wall Street Analysts

It can be difficult for a regular investor to determine the myriad of risks stocks face, so many rely on Wall Street analysts. These are financial experts that research companies in a specific industry and make recommendations about which stocks investors should buy, hold or sell. Much of their analysis is based on business risk and balance sheet strength, although they also focus on other things like market trends and projected growth. However, even professionals can underestimate business and other forms of risk, so simply following their recommendations is not a guarantee that an investor will make money and avoid losses.

[Terry Mann,2010]

 

 

 

 

 

 

 

 

 

 

BALANCING RISK AND REWARD

 

The balance between risk and reward is the very essence of business: without 
taking risks companies cannot generate profits. There is a world of difference between calculated risks, taken with foresight and careful judgement, and risks taken carelessly or unwittingly. 
The starting point for boards is to oversee risk in relation to their organisation's 
risk 'appetite' and 'tolerance' and to align their approach to risk with its broader 
strategic aims.

In a world of increasing complexity and uncertainty, companies must build on 
this foundation to manage risk more rigorously than ever.

A few fall victim to 'black swan' events - catastrophic external factors that are 
entirely outside the company's control - so rare and random that they challenge 
the ability of organisations to plan for them. But many simply fail to understand 
the extent of the dangers to which they are exposed. Board members are 
particularly culpable, often underestimating the risks that their organisations 
run, while also being blind to the dangers they face in a personal capacity, which 
can result in financial penalties, criminal actions and ruined reputations.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RISKS IN THE REAL WORLD

 

Some traditional risks remain common to all businesses, including risks related 
to 'bricks and mortar', product liability and employer's liability, among others. 
Beyond these general business risks, different types and sizes of company tend to 
face different sorts of risk. For example, small companies are especially 
vulnerable to cashflow and credit risk, historically two of the greatest causes of 
business failure when mishandled. In today's difficult economic climate, small 
firms are also more vulnerable to threats such as fraud, crime and vandalism.

The risk profile for mid-corporates too, has changed in response to tough 
times. A 2010 report by Chartis, Risk and Opportunity in the Mid Corporate Sector,concluded that companies of this size (£5m-£50m turnover) perceive the 'post-crisis' world as a much more uncertain place. Over 80% think that risks now seem more real - in terms of the seriousness of the impact they could have on their 
business - compared with five to 10 years ago, while a similar majority believe 
there are also more risks to worry about.

The research showed their top concerns as:

■ Safety of physical assets (30% of respondents)

■ Public liability (28%)

■ Employer's liability (25%)

■ Debtors/bad debts (21%)

■ Professional indemnity and negligence (16%)

■ Crime and vandalism (14%)

■ Staff turnover (14%)

■ Product liability (14%)

■ Business interruption (14%)

■ Volatileglobalmarkets(12%)

 

 

 

 

 

 

 

 

Conclusion

“If you do not risk, then you risk most of all – that is the difficulty”. You won’t get positive results if you do not risk. In my work we understand what is risk, it’s types and implications, how to use it and it’s role in business.

Before making risk, it is necessary to think hard, to “weigh everything” and to understand should it  be or not.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

References

1. Business Knowledge Resource

http://business.gov.in/growing_business/business_risks.php

2. Dana Griffin, “Types of Business Risk”, 2008
3. Osmond Vitez, “Implications of Business Risk”, 2009
4. Terry Mann, “Usage of Business Risk”, 2010
5. Lysanne Currie, “Business Risk. A Practical Guide for Board Members”, 2012
6. Investopedia,

http://www.investopedia.com