A lesson some business leaders learn the hard way is that in today’s global operating environment risks appear to be increasing exponentially. It takes only one trial by fire for a leader to recognize the importance of basing each decision in part on its risk versus its reward.
It’s important that a leader maintain a steady focus on business risk, lest his business suffers a loss that can drastically brunt all efforts to increase the company’s performance, its net worth and the value of company shares.
A leader must take steps to defend against business risks to protect his company’s operational and financial well-being. To do so, he must learn to identify and classify each business risk depending on its origin and characteristics.
The Origins of Business Risk
A leader assumes business risk – the possibility actual returns will be more or less than expected returns – the moment a company’s lights are turned on and its doors are flung open.
The types and scale of the risks that affect the long-term success of a business will depend on the company’s operations and industry. For example, new market entrants, shifts in consumer demand and economic downturns are risks to some companies in the media and entertainment industry. In turn, companies in the mining industry may deal with a shortage of skilled labor and access to infrastructure.
A financial risk can impact your company’s cash flow and income. Because investors may value your business by discounting its projected cash flows, financial risks can also affect shareholder wealth.
Financial risks include liquidity risk, which can affect retained earnings, as well as capital if a company becomes unable to meet its current liabilities without suffering significant losses. Financial risk also includes market risk, such as changes in commodity prices, credit spreads, interest rates or equity prices.
Financial risk also comprises company reporting risk or the possibility that a company report accounting, tax or regulatory data that’s inaccurate or reported in an untimely manner. Other financial risks include credit risk – the inability to meet financial obligations when due — and capital structure risk — a company’s debt to equity ratio, which is determined by the way a business finances operations.
Your company’s strategic risk is determined by its business functions, investor communications and operating environment. A company’s operating environmental risk is affected by the markets in which it buys and sells goods and services.
Environmental risk also depends on the government regulations and compliance requirements that govern your company’s operations and markets. In turn, unfavorable changes in the supply or demand of products or services also affect a company’s strategic risk, as do the competitors that vie for sales and supplies in your chosen markets.
Operational risk (process risk and innovation risk) concerns your company’s internal activities. Process risk relates to resources, such as employees, equipment, materials and business processes, that support production processes or affect your company’s continued operations.
In turn, innovation risk depends on the success or failure of performance improvement initiatives or business process upgrades. Innovation risk also relates to the degree a company’s investment in incremental product improvements is rational and its approach to the development of new products.
Business leaders consider a number of criteria during a decision-making process, not the least of which is business risk. To best ensure a business doesn’t suffer a catastrophic loss that puts continued operations in doubt, a leader must manage the business risk. A first step in the process is identifying and classifying relevant business risk, including strategic, financial and operational risks.