Components of Business Risk

by Osmond Vitez; Updated September 26, 2017

Risk is a natural part of business. While no risk is unavoidable by companies, they can maximize their return by properly managing each type of risk they face in the economic marketplace. Management must understand the major types of risk their companies face and how each can be avoided. Business risks can affect companies one at a time or through a combination of decisions made by management.

Product Risk

The biggest risk a company faces is offering products or services for sale to consumers. Offering products that consumers do not want or need quickly creates a negative impact on a business, both financially and professionally. Additionally, offering a faulty product or a cheaply made product for a high price can also create high business risk. Conducting proper product analysis through customer surveys or market sampling will ensure that companies offer goods and services consumers desire.

Market Risk

Each business operates in an economic marketplace, which has boundaries and limitations that companies cannot exceed or ignore. Failing to understand the marketplace limits, such as supply, demand, or price will create unprofitable situations for a company and lead to department failures or company bankruptcy. Market risk can also include competitors, which will limit the amount of market share companies can gain when entering new markets or industries. Conducting an economic growth forecast will help management determine the health and growth opportunities in a market or industry.

Finance Risk

Financing is used by all companies to start new operations or expand current operations. When companies use too much leverage, bank loans or credit lines to finance their operations, cash flow will be severely limited because banks require monthly repayments. Public companies can use stock sales to finance operations, but issuing too much stock will dilute earnings and narrow the field of investors willing to invest money in the company.

Execution Risk

Even if a company has a great product idea that will meet consumer demand, a poorly executed business plan will sink any opportunities for the company to earn a profit. Overpaying for raw materials, labor, or production facilities will raise production cost, causing companies to set consumer prices higher than the market is willing to pay. Generating high administrative costs from marketing or support operations will also lead to unprofitable operations, destroying the opportunities from solid products or production methods.

Business Risk

Business comes from underestimating cash flows from business operations. Many companies have high sales, great products, or efficient production methods, that is, their ability to turn these activities into the cash necessary to run their operations. Poor cash collections will lead companies to run their business using short-term bank financing, which raises the risk of becoming overleveraged.