Risk is usually defined as the uncertainty of a result or an event. It can refer to both a negative threat and a positive opportunity for a company to take a risk that is worthwhile and can bring a competitive advantage over risk-averse competitors. However, considering the potential for significant losses as well as profits, it is important that risks are accurately assessed, calculating the likelihood of the results as well as their impact on a business.
All businesses face risks, as they operate in an environment of uncertainties inherent in the free market that puts any economic activity at the mercy of supply and demand. Thus, every business must have a system in place to manage these results. This typically involves identifying, as accurately as possible, the potential risks and their likely impact on the company, and then developing appropriate and prepared responses to address such events, if and when they occur. Risks originate from several different areas:
- Strategic risks include market-related uncertainties, such as declining demand, failure to develop new products, or entry of new competitors.
- Financial risks relate to changes in costs and revenues not directly linked to the market and may include bad debts or increases in interest payments on loans.
- Operational risks cover the dangers of turbulence in the distribution and production functions, such as faults in factory machinery or loss of important personnel.
Finally, compliance risks relate to the company’s ability to meet legal and regulatory requirements. Failures in this case can result in the forced closing of the deal or threats of legal action. Other more general risks would include natural catastrophes and political instability in foreign markets.
Once risks are identified, it is important for the business to assess the likelihood that they will occur, as well as their impact or significance. Thus, the business can classify or prioritize the risks it will face. This classification makes it possible to concentrate resources on the most important risk areas, those that have the greatest potential to impact the success of the company’s objectives. The risk estimate can be obtained at a basic level, simply by assessing whether the results are low, medium or high probability. At a more sophisticated level, risks can be analyzed by applying current science.
The final step is to develop systems or policies to manage risk. The first approach is simply to accept the risk. This usually means that the costs of managing the risk outweigh the costs of the risk itself. Risks that cannot be avoided or transferred fall into the “self-insurance” category. The second strategy is to transfer the risk. This is usually done with the purchase of an insurance policy. The risk can also be transferred by contractual agreement (for example, the buyer can agree to cover all production prices from a supply company)
The third is to reduce the risk by making several investments, such as buying better, more expensive machines, but with less likelihood of inconvenience.
The final approach is to avoid the risk. It means that activities or investments will not be undertaken, as the risks are considered to be very high. The problem with this approach is sometimes that you have to give up lucrative opportunities.
