A certain risk level is inherent in running a business, and a company cannot completely eliminate risk. However, a business can control or at least successfully manage risk. In order to do so, management must make decisions and choices regarding acceptable risk levels relative to potential profits. In this context, there are a number of sources of risk for any business to consider, including risks from the marketplace, employee-related risks, and financing risks.
Risk Management
A company must inevitably assume some level of risk to generate returns on investments that will be satisfactory to its stockholders. The key to successful risk management is maintaining a good balance between risk and reward, which involves carefully weighing potential profits against potential problems or threats to operational stability.
Key Takeaways
- Business risk cannot be totally eliminated, but steps can be taken to mitigate the negative impact.
- A contingency plan (to deal with issues as problems arise) is a vital component of risk management.
- The marketplace in which a company operates is a primary source of risk if demand slows or new competitors enter the fray.
- Sometimes a company can have difficulty obtaining financing to start or continue a project, which represents another source of risk.
- Labor disputes and other employee-related issues can create risks for a business.
A large part of risk management is an understanding of potential risks and having contingency plans in place to deal with problems that may arise. For example, if a company’s management knows it will need additional financing to complete an expansion project, good risk management is having a backup source of financing available if the company’s primary financing source is unwilling to extend the company additional credit.
Operating Profit
The marketplace in which the company operates is a primary source of risk. Many marketplace-related risks cannot be directly controlled; they can only be managed and dealt with as best as possible. For example, there is a risk that consumer demands or desires may change, resulting in less demand for the company’s products. There are risks that the company’s products could injure someone and result in a lawsuit. There is the risk that a competitor may introduce a product that makes the company’s product less desirable to consumers or that a competitor may offer a competing product at a substantially lower price, threatening either the number of sales or operating profit margin. There is always the risk of a general economic downturn that makes consumers less able to purchase the company’s products, resulting in fewer sales.
Cash Flow
Numerous business risks are associated with financing and cash flow. A company may be unable to obtain the necessary financing for an expansion project. The company’s customers may experience financial problems that make them unable to pay invoices on a timely basis, disrupting the company’s cash flow. Suppliers may unexpectedly raise prices, creating working capital or cash flow problems for the company or causing it to have inadequate inventory on hand when needed.
Employee-Related Issues
Employee-related issues are another source of business risk. Labor problems may arise that impact a company’s production. The need to retain certain key personnel may result in increased wage costs. Loss of key personnel can affect the company’s performance and profitability—for example, if one of the company’s top salespeople takes a job with another firm, or if the company loses a key product designer. Included in this risk category is management risk—the risk of bad management decisions for a company.
International Risk
Lastly, if a company does business internationally, then there are several other potential risks: political problems, changes in tariffs or import/export laws, and risks associated with fluctuating currency exchange rates. While currency exchange rate risk can sometimes be managed through hedging activity in the foreign exchange market, events of a legal or political nature are often unpredictable and not amenable to risk management strategies.