Definition: By the term ‘business risk’ we mean the uncertainty with respect to firm’s operations. It is a type of systematic risk wherein there is a volatility associated with the future income or earnings arising from events, circumstances, conditions, action, or inactions that hinders the attainment of goals and objectives and carry out the strategies.
Business risk refers to the anticipation that the firm may earn lower than expected profits or even suffer losses, because of the uncertainties inherent in the business such as competition, change in customer tastes and preferences, input cost, change in government policies, and so forth. It may impede the business ability to provide returns on the investment.
Factors Influencing Business Risk
Business risk emerges out of competition, market conditions, product mix, etc. The two primary factors that result in business risk are:
- Internal Risk: The risks that emerge as a result of the events occurring within the organization is termed as an internal risk. These risks can be predicted as the possibility of their incidence, and so, they are controllable in nature.They arise due to factors like strikes & lockouts by a trade union, accidents in the factory, negligence of workers, failure of the machine, technological obsolescence, damages to the goods, fire outbreak, etc.
- External Risk: The risk arising as a result of the events external to the firm and so the firm’s management has no control over it. So, these cannot be forecasted easily. It may arise due to price fluctuations, changes in customer taste, earthquake, floods, changes in government regulations, riots, etc.
Standard Deviation of the Basic Earning Power Ratio helps in the measurement of Business Risk.
Classification of Business Risk
There are various types of business risk, as discussed below:
- Strategic Risk: The risks related to the business strategies, plans and tactics, as there is uncertainty with respect to their successful implementation, it is called a strategic risk.
- Financial Risk: The risk added to the shareholders, when the company uses debt financing along with equity, is termed as a financial risk.
- Operational Risk: When the company fails in performing day to day operations properly, then operational risk arises.
- Compliance Risk: Such risks are related to the need of the firm to adhere to government rules, regulations and policies.
- Reputation Risk: The reputation risk arises due to any of the previous business risks or by negative publicity with respect to a misleading advertisement, lawsuit etc.
Apart from those given above, there are some other risks related to natural calamities like floods, earthquake, droughts, etc. which also affects the business at large.