Business RiskTypes along with examples

Denise Elizabeth P
Senior Financial Editor & Contributor
Last Updated: April 25, 2022
Date Published: April 25, 2022

What is Business Risk?

Business is not all about earning profit in an instant but to become truly profitable, the business organization must take into consideration all the possible risks it may encounter internally or externally.

Anything that threatens the realization of a company’s financial goals is called business risk. This type of risk is inherent to all organizations and may affect the ability of a company to generate a profit.

Business risks may come from both internal and external factors.

Internal risks are brought about by the management and top leadership of an organization.

External business risks are impossible to eradicate but what the management can do is mitigate these risks with the appropriate risk management strategy. 

Understanding Business Risk

Internally speaking, when there is a business risk, it is not only the operating profit of the company that will be affected but also the owners, partners, or investors.

With a high level of business risk, it can seriously hurt the ability of the company to generate profit, and the lesser the income, the lesser the equity distributions. 

The different factors that may trigger a higher level of business risks are inflation (an increase in input cost), changes in supply and demand, market competition, changes in rulings within the applicable regulating authorities, and economic crises.

There are two types of risk that are associated with the business risk: Systematic and Unsystematic risk.

Systematic risks are uncontrollable risks. The examples of which are economic crises brought about by a pandemic, political crises, and other risks that can cause the economy to fluctuate. Unsystematic risks on the other hand are somewhat controllable.

When a company has a high business risk, adopting a capital structure with a low debt ratio will ensure that when revenues falter, the company will have enough to pay for its obligations. 

To even better analyze the ratio of the risks four ratios can be used to gauge the business risk: contribution margin, degree of operating leverage, degree of financial leverage, and the total degree of leverage.

Business risks can either occur as a strategic, compliance, operational, or reputational risk. 

Types of Business Risk

business risk

Strategic Risk

This happens when a certain business model has not been properly followed and implemented by the management.

It may affect the management’s ability to achieve the organization’s goal.

For example, a coffee shop decided to give away a coffee mug for every purchase of any of their cold drinks, but because of inflation, the materials used to produce a coffee mug increased.

Because of this strategy, unexpected additional costs could arise.

Compliance Risk

The few hiccups that management experience with this type of risk is because of the complexity of the rules and regulations of a certain regulating body.

Also, sudden changes or updating of the said rulings may cause confusion to the company.

For example, without the knowledge of the newly implemented regulations of the Environmental Protection Agency regarding hazardous waste, a plastic company that continues to burn a large amount of scrap plastic risks non-compliance with the regulation.

Operational Risk

This can be caused by the inefficiency of internal operations.

The joint effort of the leaders and the workers must be seen to achieve the organization’s goal but if this has been neglected, it can affect the day-to-day operations and can cause the poor overall output of the management.

For example, a manufacturing company is producing a large number of pencils every day, and because of everyday operations, the machine that is used to curve the cedar wood (the type of wood used in producing pencils) malfunctioned, unfortunately, there has been no mechanical engineer available at that moment and the production needed to be stopped resulting to low production of the supply and lower sale. 

Reputational Risk

It is essential that companies build a good impression on the public, making sure that people know your brand and what it represents.

If a company fails to set a good buyer-seller relationship, the sales of the company will be the receiving end of this negativity.

For example, after the incident of the rude behavior of two employees in a certain clothing line, the video leaked on social media and became viral.

It created a negative campaign against the brand and sales decreased. 

Special considerations

Business risk can be caused inherently or non-inherently, but whatever the risk may be, there can be a solution to each type of risk.

Not all risks can be prevented but somehow, the management can mitigate the impact of the strategic, compliance, operational, and reputational risks.

Management planning or business planning is an important tool that a company’s top leadership and management can prepare, outlining all the risks that the company may face.

A plan to take action when the risks present themselves before they blow out of proportion is a key element. 

Taking action is one thing, documenting it is another.

Management must also include the steps taken by the management to mitigate the impacts of the risk to be prepared when a similar situation reappears in the future. 

A Risk Management Strategy is a plan containing procedures and tested ideas to address risks as they come up or be better prepared when risks appear in the future.

This strategy can also be improved when the company experiences a setback.

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  1. Notre Dame of Maryland University "4 Common Business Risks Modern Companies Face" Page 1 . April 25, 2022

  2. University of the People "What Is A Business Risk And How Should You Plan For It?" Page 1 . April 25, 2022

  3. University of Southern Indiana "Risk Assessment When Making Business Decisions" Page 1 . April 25, 2022