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Managing Business Risk

Every business organisation involves some element of risk and successful business are those , who are able to properly manage the risk. Risk implies uncertainty of profits or danger of loss due to some unforeseen events that may occur in the future. An entrepreneur may encounter risks in every area or function of a business and it is said, the more risky the business , the more are chances of getting high returns. Business risks may take place in a variety of forms. Though risks are universal, but the nature and degree of risk differ from business to business. They may vary according to the nature and size of a business.

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
• Implementing a Risk Assessment Policy

A pro-active entrepreneur can face the risks effectively by anticipating their nature and causes and adopting suitable techniques in order to minimise their negative consequences.

Types of Business Risks

Business Risks may be broadly classified into two types:

	Internal Risk
	External Risk

Internal Risks

Internal Risks arise from the events taking place within the business enterprise or risks, which are more prone to the nature of business carried on by the organization. Such risks arise during the ordinary course of a business and that they can be forecasted and the probability of their occurrence can be determined. Since these risk can be pre-determined and therefore, they can be controlled by the entrepreneur to an appreciable extent.

The various internal factors giving rise to such risks are:-

• Technological factors
  These are the unforeseen changes in the techniques of production ,r distribution or delivering services. 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
  These are the factors which result in loss or damage to the property of the business . It includes 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 business arising from the compensation paid by it to the third parties on account of intentional or unintentional damages caused to them.
  
  
• Human factors
  Business is run and managed by the Humans and therefore they form 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 to manage the organization or to take right decisions at right time etc.

External Risks

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 and therefore the resulting risks cannot be forecasted and the probability of their occurrence cannot be determined, such types of events generally happens suddenly and are therefore very difficult to manage and control.

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

• Natural factors
  These are the unforeseen natural calamities over which a business has very little or no control, what so ever. This type of risks results from events like earthquake, flood, famine, cyclone, lightening, tornado, etc. Such events may cause loss of life, property, goods and services of the business. The loss arising due to such factors is generally huge and business is effected to large extent.
  
  
• Political factors
  Most of business are subject to regulatory framework of the country and are required to follow various policies ,rules and regulations made therein. Political Factors have an important influence on the functioning of a business, both in the long and short term. Political factors basically includes 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 an enterprise.
  
  
• Economic factors
  Economic factors result from the changes in the prevailing market conditions. They may be in the form of changes in consumer behaviour, demand for the product, price fluctuations, changes in tastes and preferences of the consumers and changes in income, output or trade cycles, recession in the economy. 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.

Methods of Handling Business Risks

Risks in any business are inevitable and they cannot be eliminated completely. But a pro-active entrepreneur can control and minimise the negative consequences arising from such risks by adopting a suitable risk management strategy. The various methods that may be used for handling business risks are as follows:-

• Before undertaking any risk, it is always necessary to properly analyse the consequences of the risk i.e. the resulting loss or profit and it should only be undertaken ,if its outcome ultimately benefits the business. Otherwise, such an action should be avoided as far as possible. Though the taking the risk, also depends upon the attitude of management whether it is conservative or aggressive because there are always more chances of loss rather than profit.

In case of unavoidable risk, the entrepreneur should try to control and minimise the losses arising from the risk through efficient planning and proper risk management techniques. The main techniques that can be employed by a business are as follows:-

1. Many business risks arise due to errors in planning. Thus scientific forecasting and marketing research of future economic conditions can help the management to make appropriate plans for the enterprise in advance. This will make them aware of likely opportunities and threats to the business environment in future. Accordingly, the entrepreneur can make required changes in its products, prices of the products, its distribution channels and sales promotion techniques.
   
   
2. A firm can reduce the losses arising from technological obsolescence through continuous technological research and development in the organisation. Thus, it can develop new and innovative ways of producing goods and delivering services.
   
   
3. Credit analysis and control through careful screening of the customers; prompt collection of the outstanding debts and tight inventory control will also help the firm to reduce the amount of risks.
   
   
4. Various safety programmes like:-
   
   • Fire fighting equipment and sprinkler system will help in preventing the losses caused by fire
   • Burglar alarms, night watchman, and safety vaults will help in reducing thefts, burglary, etc
   • Cold storage or refrigeration will help in preservation of perishable products of the firm and thus reduce the damages caused to the products
   • Special packing will help in reducing any spoilage, breakage or leakage of the goods in transit or storage
   • Proper pest control methods will also help in reducing the damages caused to the products
   • Safe work environment including adequate lighting, covering of damaged floors as well as proper medical care facilities will help in reducing the number of accidents in the factory.
     
     
5. Risk of competition can be reduced through collective action by the competing firms which may agree to restrict output, allocate markets or charge uniform prices. 6. Proper Liasioning with Government departments and authorities and keeping watch on various activities and actions of the Government, can help the organization in taking right policy decisions and thereby reducing the business risks.

There are certain risks which are inherent in any form of business organisation and such risks can be handled only through proper planning and adopting two possible strategies. These are:-

1. Shifting the risks to the people who are skilled in managing them and are willing to bear them. The risks may be transferred or shifted through:-

• Hedging:- It is a method of risk transfer accomplished by buying and selling for future delivery. It is a form of forward trading to minimise losses due to changes in prices. Under it, the possibility of loss which occurs because of price fluctuations, is shifted during the time gap between purchase and sale of a commodity. It involves entering simultaneously into two contracts of an opposite though corresponding nature, one in the spot or cash market and the other in the future market. The purpose of hedging is to protect the trade profit from adverse fluctuations in commodity prices.
  
  
• Underwriting:- A public company issuing shares and debentures may face the risk of loss due to the failure to sell the entire issue of securities. Such risk can be shifted to an underwriter which is the financial intermediary between the company issuing securities and the ultimate investors. It provides several benefits to a company:-
  
  1. It relieves the company of the risk and uncertainty of marketing the securities.
  2. . Underwriters have an intimate and specialised knowledge of the capital market. They offer valuable advice to the issuing company in the preparation of the prospectus, time of floatation and the price of securities, etc. They also provide publicity service to the companies which have entered into underwriting agreements with them.
  3. It builds up investors' confidence in the issue of securities. The association of well-known underwriters lends prestige to the company and the investors feel that the issue is sound enough for profitable investment. Also the securities underwritten by reputed underwriters receives better response from the public
  4. The issuing company is assured of the availability of funds. Important projects are not delayed for want of funds.
  
  
• Subcontracting:- is an inter-firm relationship, where a small firm may produce different components, intermediate inputs and final output or it may provide various assembling activities, etc for the parent firm. Such small firms are generally known as the subcontractors. The need for subcontracting arises when a firm undertakes a business which extends over a long period of time or which requires the specialised services of several experts. In such a situation, the firm may face risks resulting from rise in prices of materials, labour or other imports. Such risks may be shifted to other firms through subcontracting. For instance, a building construction firm may engage subcontractors for timbers, glasses, electric wiring, plumbing, cement, etc.

2. Sharing the risks with other people so as to minimise the burden on the business, is an important tool of managing risk, particularly in respect of risks , which are difficult to forsee. Insurance is the most important and prevalent device for risk sharing

• Insurance: Insurance may be defined as a contract in writing under which one party agrees to indemnify the other party against a loss or damage suffered by it on account of an uncertain future, in return for a consideration called 'premium'. The person/business who gets its life/property insured is called 'Insured/Assured'. The agency which helps in entering into an insurance arrangement is called 'Insurer' or 'Insurance company'. The agreement or contract which is put in writing is called a 'policy'. An insurance policy provides the following benefits to a business concern:-

1. It provides protection against risk of loss and a sense of security to the businessmen.
2. It leads to Diffusion of risks as the burden of loss is spread over a large number of people.
3. The Credit standing of the firm is enhanced as the businessman can easily transfer some of his risks to an insurance company.
4. It provides Continuity and certainty to the business as if all the risks were to be borne by the businessmen themselves, the business operations would have been uncertain and halting in character.
5. It leads to better utilisation of the capital of the firms as the Insurance companies take over the risk, which enables the business firm to invest and optimally utilise its capital.

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