BUSINESS RISK

What is Business Risk?

Business risk refers to a threat to the company’s ability to achieve its financial goals. In business, risk
means that a company’s or an organization’s plans may not turn out as originally planned or that it may
not meet its target or achieve its goals.
Such risks cannot always be blamed on the owner of the company, as risk can be influenced by various
external factors, which may include rising prices of raw materials for production, growing competition, or
changes or additions to existing government regulations.

How to Identify Business Risks

Risks are inherent to every environment and business. They cannot be avoided and, therefore, must be
addressed head-on to minimize their impact. The first step in risk management is to identify the risks in
order to come up with a risk management strategy.

1. Analyze the sources that may trigger problems

It is important to identify and analyze the sources that can cause a problem. Risk triggers can be internal
or external.

2. Act now
Managers shouldn’t wait for potential problems to become actual problems before they start doing
something. The moment a problem is deemed to be a threat, it should immediately be dealt with by the
company’s executives by devising a plan of action in the event that the risk becomes an actual full-blown
concern facing the company.

3. Involve employees
Identifying risks is not the sole responsibility of the managers and top-ranking officials. Management
should involve their employees in identifying the risks that they see in their respective departments and
train them to handle such risks at their level.

4. Make a list of industry-specific risks

By looking into the industry where the company operates, managers will be able to identify the possible
risks that the business may face. If the same risks happen to other companies in the same industry, there
is a likely chance that it will happen to your company as well. Therefore, businesses should be ready with
a list of solutions or steps to address the risks.

5. Create a record of risks

Sometimes, the same risks arise over and over. By creating a record of all the risks experienced by the
company since it started, management will be able to do a regular review of past events in order to detect
patterns that may better prepare the company for future risks.

Types of Risks in Business

Risks come in different forms. Below are the different types of business risks:

1. Strategic risk
Strategic risks can occur at any time. For example, a company manufacturing an anti-mosquito lotion may
suddenly see a decline in its sales because people’s preferences have changed, and they now want a
spray mosquito repellent rather than a lotion. To deal with such risks, companies need to implement
a real-time feedback system to know what its customers want

2. Compliance risk
Compliance risk involves companies having to comply with new rules that are set by the government or
by a regulatory body. For example, there may be a new minimum wage that must be implemented
immediately.

3. Financial risk
Financial risk is about the financial health of the company. Can the company afford to offer installment
payments to its customers? How many customers can it offer such an installment scheme? Can it handle
business operations when two or three of these customers are not able to make their payments on time?

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 4. Operational risk
Operational risk occurs within the business’ system or processes. For example, one of its production
machines may break down when the target output is still unmet. What will the company do if one of its
machine operators has an accident during work hours?

 Causes of Business Risks

There are basically three causes of business risk:

1. Natural causes
Natural causes of risk include flooding, earthquakes, cyclones, and other natural disasters that can lead
to the loss of lives and property. For example, a delivery truck is on its way to deliver the order of a
customer but is met with a cyclone along the way, causing an accident. In order to counter such causes,
businesses need to take out comprehensive insurance coverage.

2. Human causes
Human causes of risk refer to negligence at work, strikes, work stoppages, and mismanagement.

3. Economic causes
Economic causes involve things such as rising prices of raw materials or labor costs, rising interest
rates for borrowing, and competition.

How to Manage Business Risks

Business risks may be inevitable, but there are several ways to minimize their impact, such as:

1. Avoid the risk

It may sound ironic to suggest avoiding the risk when we say that it is inevitable. But what is meant here
is that companies should avoid specific risks when possible. Managers should think of alternatives in
order to not have to face the risk.

2. Prevent the risk

In the example of the delivery truck above, it would help prevent the risk if companies check on the
weather prior to sending out deliveries in order to make sure they reach their destination safely. If there is
a deemed risk, then they should act to prevent it from happening – for example, by halting deliveries
during severe weather.

3. Contain the risk

Sometimes, there are risks that cannot be avoided or prevented. Companies can choose to contain said
risks while putting up safety nets. For example, since all businesses need to access the internet, where
hackers abound, they may put stronger firewalls and other protective measures in place to ensure their
company’s safety.

Risk Management

Because risk is the possibility of a loss, people, organizations, and society usually try to minimize or
manage risk. Risk management can be subdivided into 2 broad categories: risk control, avoiding or
reducing risk, and risk financing, setting enough money aside to cover losses or transfering the risk
to 3r d  parties, such as insurance companies. Within these categories, there are 5 major methods of
handling risk:

1. Risk Control
A. avoidance
B. loss control
2. Risk Financing
A. retention
B. noninsurance transfers
C. insurance

Risk Control

Risk control is the best method of managing risk and usually the least expensive. Risk control
involves avoiding the risk entirely or mitigating the risk by lowering the probability and magnitude of
losses. Many risks cannot be avoided, but almost all risks can be mitigated through the use of loss

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 control. Nonetheless, even losses from mitigated risks can be expensive, so both people and
businesses usually transfer some of that risk to 3r d  parties.

Risk avoidance is the elimination of risk. You can avoid the risk of a loss in the stock market by not
buying or shorting stocks; the risk of a venereal disease can be avoided by not having sex, or the
risk of divorce, by not marrying; the risk of having car trouble, by not having a car. Many
manufacturers avoid legal risk by not manufacturing particular products.

Of course, not all risks can be avoided. Notable in this category is the risk of death. But even where
it can be avoided, it is often not desirable. By avoiding risk, you may be avoiding many pleasures of
life, or the potential profits that result from taking risks. A business cannot operate without taking
some risk. Virtually any activity involves some risk. Generally, risk should be avoided when losses
are large and gains are small. Where avoidance is not possible or desirable, loss control is the next
best thing.

Loss control (a.k.a. risk reduction) can either be effected through loss prevention, by reducing

the probability of risk, or loss reduction, by minimizing the loss.

Loss prevention requires identifying the factors that increase the likelihood of a loss, then either
eliminating the factors or minimizing their effect. For instance, speeding and driving drunk greatly
increase auto accidents. Not driving after drinking alcohol is a method of loss prevention that
reduces the probability of an accident. Driving slower is an example of both loss prevention and loss
reduction, since it both reduces the probability of an accident and, if an accident does occur, it
reduces the magnitude of the losses, since accidents at slower speeds generally cause less
damage. Salvage operations may also reduce the cost of the loss.

Most businesses actively control losses because it is a cost-effective way to prevent losses from
accidents and damage to property, and generally becomes more effective the longer the business
has been operating, since it can learn from its mistakes. Businesses can control losses through
either an engineering approach or behavioral approach. The engineering approach sets up both
the business environment and procedures to lower the probability of losses. For instance, using
robots to perform hazardous procedures eliminates the risk of having people perform those
procedures. The behavioral approach recognizes that many losses are incurred because of human
error or lack of training, so workers are trained to follow procedures that will lower the probability of
losses or the magnitude of those losses. Monitoring the workers to ensure that they are practicing
safety is another effective means of loss control.

Risk Financing

Risk financing focuses on methods for paying for losses, which is necessary because not all losses
can be prevented. Risk financing is accomplished by retaining the risk, and for some risks, some or
most of the cost of potential losses is transferred to 3r d  parties, usually insurance companies.
Although insurance is a major means of lowering the cost of losses, all people and businesses retain
some risk, even for insured losses, because most forms of insurance have deductibles, and some
have copayments.

Risk retention, (aka active retention, risk assumption), is handling the unavoidable or unavoided

risk internally, either because insurance cannot be purchased or it is too expensive for the risk, or
because it is much more cost-effective to handle the risk internally. Usually, retained risks occur with
greater frequency, but have a lower severity. An insurance deductible is a common example of risk
retention to save money, since a deductible is a limited risk that can save money on insurance
premiums for larger risks. Businesses actively retain many risks — what is commonly called self-
insurance — because of the cost or unavailability of commercial insurance.

Passive risk retention is retaining risk because the risk is unknown or because the risk taker either
does not know the risk or considers it a lesser risk than it actually is. For instance, smoking
cigarettes can be considered a form of passive risk retention, since many people smoke without
knowing the many risks of disease, and, of the risks they do know, they don't think it will happen to
them. Another example is speeding. Many people think they can handle speed, and that, therefore,
there is no risk. However, there is always greater risk to speeding, since it always takes longer to
stop or change direction, and, in a collision, higher speeds will always result in more damage and a
higher risk of serious injury or death, because higher speeds have greater kinetic energy that will be
transferred in a collision as damage or injury. Since no driver can possibly foresee every possible
event, there will be events that will happen that will be much easier to handle at slower speeds than
at higher speeds. For instance, if someone fails to stop at an intersection just as you are driving
through, then, at slower speeds, there is obviously a greater chance of avoiding a collision, or, if

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 there is a collision, there will be less damage or injury than would result from a higher speed
collision. Hence, speeding is a form of passive risk retention.

Insurance

What Is Insurance?

Insurance is a contract, represented by a policy, in which an individual or entity receives financial

protection or reimbursement against losses from an insurance company. The company pools clients'
risks to make payments more affordable for the insured.

Insurance policies are used to hedge against the risk of financial losses, both big and small, that may
result from damage to the insured or her property, or from liability for damage or injury caused to a third
party.

How Insurance Works

There is a multitude of different types of insurance policies available, and virtually any individual or
business can find an insurance company willing to insure them—for a price. The most common types of
personal insurance policies are auto, health, homeowners, and life. Most individuals in the United States
have at least one of these types of insurance, and car insurance is required by law.

Businesses require special types of insurance policies that insure against specific types of risks faced by
a particular business. For example, a fast-food restaurant needs a policy that covers damage or injury
that occurs as a result of cooking with a deep fryer. An auto dealer is not subject to this type of risk but
does require coverage for damage or injury that could occur during test drives.

There are also insurance policies available for very specific needs, such as kidnap and ransom (K&R),
medical malpractice, and professional liability insurance, also known as errors and omissions insurance.

Insurance Policy Components

When choosing a policy, it is important to understand how insurance works.

A firm understanding of these concepts goes a long way in helping you choose the policy that best suits
your needs. There are three components (premium, policy limit, and deductible) to most insurance
policies that are crucial.

Premium
A policy's premium is its price, typically expressed as a monthly cost. The premium is determined by the
insurer based on your or your business's risk profile, which may include creditworthiness.

For example, if you own several expensive automobiles and have a history of reckless driving, you will
likely pay more for an auto policy than someone with a single mid-range sedan and a perfect driving
record. However, different insurers may charge different premiums for similar policies. So finding the price
that is right for you requires some legwork.

Policy Limit
The policy limit is the maximum amount an insurer will pay under a policy for a covered loss. Maximums
may be set per period (e.g., annual or policy term), per loss or injury, or over the life of the policy, also
known as the lifetime maximum. 

Typically, higher limits carry higher premiums. For a general life insurance policy, the maximum amount
the insurer will pay is referred to as the face value, which is the amount paid to a beneficiary upon the
death of the insured.

Deductible
The deductible is a specific amount the policy-holder must pay out-of-pocket before the insurer pays a
claim. Deductibles serve as deterrents to large volumes of small and insignificant claims. 

Deductibles can apply per-policy or per-claim depending on the insurer and the type of policy. Policies
with very high deductibles are typically less expensive because the high out-of-pocket expense generally
results in fewer small claims.

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Special Considerations
With regard to health insurance, people who have chronic health issues or need regular medical attention
should look for policies with lower deductibles.

Though the annual premium is higher than a comparable policy with a higher deductible, less expensive
access to medical care throughout the year may be worth the trade-off.

General Liability Insurance

Also known as general (or commercial) liability insurance, this type of coverage protects you and your
company from “general” bodily injury and property-damage claims – and is something no business should
do without. Some of the factors that go into a business liability quote include:

 Any prior losses

 Track record
 Annual sales and payroll
 Number of employees
 Square footage Prior coverage
 Details about your products or services
 Commercial credit score

What does business liability insurance cover?

Business liability insurance coverage protects you, your business and your employees from claims
involving bodily injury or property damage, up to the limits on your policy. Some common business liability
claims involve slips and falls due to poor lighting, wet floors, icy sidewalks, uneven pavement and loose or
missing handrails.

What is professional liability insurance?

Professional liability insurance can protect you and your business from lawsuits caused by charges of
negligence, errors, omissions and malpractice. As the name suggests, professional liability insurance is
designed for consultants and other professionals, such as accountants, architects, church counselors,
funeral directors, health-care workers and veterinarians.

What does professional liability insurance cover?

Professional liability insurance policies can cover judgments, attorney fees, court costs and settlements
when claims are made against you or you are sued for the professional services you provide – even if
claims are found to be unwarranted. Professional liability insurance can also cover the insurance
company’s investigation and attorney expenses, bodily injury or property claims resulting from accidents
on your property or from your operations, as well as advertising injuries, such as slander, libel or copyright
infringement. 

Questions for Review and Discussion

1. What is risk? How may it affect business firms?

2. What are the methods of handling risk?

3. What are usually contained in the insurance policy?

4. From the business viewpoint, what benefits are derived from the availment of insurance
services provided by insurers?

5. What type of coverage may be availed of under the business liability insurance policies?

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Assessment

Write a brief reflection statement explaining how this lesson changed your perspective of
“risk” especially when venturing a business. Minimum of one-page-essay.

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