The contemporary business environment is a highly dynamic one. Constant changes in the external environment have increased the risks that businesses face. Risk management has therefore become more important than ever.
Key risks that a business faces are operational risks and financial risks. Operational risks are those that arise from the nature of operations of a business. For instance a sudden, unexpected shortage of raw materials for your business is an operational risk. Sudden, unexpected fall in the prices of the products or services of your business is another operational risk. Occupational hazards to which workers of a business are exposed to are also an operational risk.
Operational risks can be managed by constantly monitoring the external and internal environment. Scenario analysis should be done to plan for a business’ response in the case of materialization of a possible operational risk scenario. Operational risks such as fire in plants and facilities can be managed through adequate insurance. Unfortunately, majority of businesses are under-insured. Many small businesses operate without any kind of insurance.
Financial risks before a business are of many types. A business involved in exports and imports faces foreign exchange risk. This risk means loss in the value of revenues or assets or increase in the value of liabilities due to sudden, unexpected movements in foreign exchange rate. For instance a company exporting mangoes from India to America earns its revenues in dollars, which it then converts to rupees. If the dollar depreciates against the rupee then the revenue of this company in rupee terms will go down. Such type of currency risk can be managed through the technique of hedging.
Credit risk is another type of risk that can be classified as a financial risk for a business. Credit risk means that the debtor of your business may fail in paying off its debt obligation when it becomes due. A lot of sales – especially in business-to-business (B-2-B) segment – are credit sales. Therefore credit risk is high in these cases.
Market risk means that the value of an investment will decrease because of adverse movements in market prices. Businesses keep their cash reserves invested in various investment schemes and securities and are therefore exposed to market risk.
Then there is the financial risk of insolvency. Risk of insolvency means a business or individual getting insolvent because of its inability to pay off its debt or financial obligations when they become due.
Both small and large businesses should focus on making their risk management more effective. Poor risk management by banks and many large companies was the main reason for the 2008 financial crisis.