What is Risk ? Explain categories of risk.
Answers
Businesses face all kinds of risks, some of which can cause serious loss of profits or even bankruptcy. But while all large companies have extensive "risk management" departments, smaller businesses tend not to look at the issue in such a systematic way.
So in this four-part series of tutorials, you’ll learn the basics of risk management and how you can apply them in your business.
In this first tutorial, we’ll look at the main types of risk your business may face. You’ll get a rundown of strategic risk, compliance risk, operational risk, financial risk, and reputational risk, so that you understand what they mean, and how they could affect your business. Then we’ll get into the specifics of identifying and dealing with these risks in later tutorials in the series.
1. Strategic Risk
Everyone knows that a successful business needs a comprehensive, well-thought-out business plan. But it’s also a fact of life that things change, and your best-laid plans can sometimes come to look very outdated, very quickly.
This is strategic risk. It’s the risk that your company’s strategy becomes less effective and your company struggles to reach its goals as a result. It could be due to technological changes, a powerful new competitor entering the market, shifts in customer demand, spikes in the costs of raw materials, or any number of other large-scale changes.
History is littered with examples of companies that faced strategic risk. Some managed to adapt successfully; others didn’t.
A classic example is Kodak, which had such a dominant position in the film photography market that when one of its own engineers invented a digital camera in 1975, it saw the innovation as a threat to its core business model, and failed to develop it.
2. Compliance Risk
Are you complying with all the necessary laws and regulations that apply to your business?
Of course you are (I hope!). But laws change all the time, and there’s always a risk that you’ll face additional regulations in the future. And as your own business expands, you might find yourself needing to comply with new rules that didn’t apply to you before.
For example, let’s say you run an organic farm in California, and sell your products in grocery stores across the U.S. Things are going so well that you decide to expand to Europe and begin selling there.
That’s great, but you’re also incurring significant compliance risk.
Even if your business doesn’t expand geographically, you can still incur new compliance risk just by expanding your product line. Let’s say your California farm starts producing wine in addition to food. Selling alcohol opens you up to a whole raft of new, potentially costly regulations.
In extreme cases, a compliance risk can also affect your business’s future, becoming a strategic risk too.
3. Operational Risk
So far, we’ve been looking at risks stemming from external events. But your own company is also a source of risk.
Operational risk refers to an unexpected failure in your company’s day-to-day operations. It could be a technical failure, like a server outage, or it could be caused by your people or processes.
In some cases, operational risk can also stem from events outside your control, such as a natural disaster, or a power cut, or a problem with your website host. Anything that interrupts your company’s core operations comes under the category of operational risk.
4. Financial Risk
Most categories of risk have a financial impact, in terms of extra costs or lost revenue. But the category of financial risk refers specifically to the money flowing in and out of your business, and the possibility of a sudden financial loss.
For example, let’s say that a large proportion of your revenue comes from a single large client, and you extend 60 days credit to that client .
In that case, you have a significant financial risk. If that customer is unable to pay, or delays payment for whatever reason, then your business is in big trouble.
Having a lot of debt also increases your financial risk, particularly if a lot of it is short-term debt that’s due in the near future. And what if interest rates suddenly go up, and instead of paying 8% on the loan, you’re now paying 15%? That’s a big extra cost for your business, and so it’s counted as a financial risk.
That’s a big financial risk to take into account.
5. Reputational Risk
There are many different kinds of business, but they all have one thing in common: no matter which industry you’re in, your reputation is everything.
If your reputation is damaged, you’ll see an immediate loss of revenue, as customers become wary of doing business with you.
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