Thursday, February 10, 2011

Business Risks

Business Risks
Generally every business has two types of risks;
  1. Strategic Risks: Strategic risks are risks that relate to the fundamental decisions that the directors take about the future of the organization.
  2. Operational Risks: Operational risks relate to matters that can go wrong on a day-to-day basis while the organization is carrying out its business.
There are many different types of risks faced by commercial organizations, particularly those with international activities. 

1 - Strategic Risks
Strategic risk is the potential volatility of profits caused by the nature and type of the business operations. The most significant risks are focused on the strategy the organization adopts including concentration of resources, mergers and acquisitions and exit strategies. As organization also needs to guard against the risks that business processes and operations are not aligned to strategic goals, or are disrupted by events that are not generated by business activities.

1.1  – Business and non-business strategic risks
A useful classification of strategic risks is the division between business and non-business risks.
·         Business Risks: Business risks are threats to profits, the magnitude of which depends on the decisions the organization makes about the products and services it supplies. An obvious example of business risk would be threats of long-term product obsolescence. Changes in technology would also have long term impacts of they changed the production process; the significance of these changes would depend on how important technology was in the production processes. Long-term macroeconomic changes, for example a worsening of a country’s exchange rate, would also be a business risk.
·         Non-business Risks: Non-business risks are threats to profits that are not influenced by the products or services the organization supplies. Example of non-business risks arising from the long-term sources of finance chosen and risks from a collapse in trade because of an adverse event, an accident or natural disaster.

1.2 - Factors influencing strategic risks
            Factors that determine the level of strategic risks will include:
·         The types of industries/markets within which the business operates
·         The state of the economy
·         The actions of competitors and the possibility of mergers and acquisitions
·         The stage in a product’s life cycle, higher risks in the introductory and declining stages
·         The dependence upon inputs with fluctuating prices, eg wheat, oil, etc
·         The level of operating gearing – the proportion of fixed costs to total costs
·         The flexibility of production processes to adapt to different specifications or products
·         The organization’s research and development capacity and ability to innovate
·         The significance of new technology

There may be little management can do about some of these risks, they are inherent in business activity. However, strategies such as diversification can contribute substantially to the reduction of many business risks.

2Operational Risk
Operational or process risk is the risk of loss from a failure of internal business and control processes. Operational risks include;
  • Losses from internal control system or audit inadequacies
  • Non-compliance with regulations or internal procedures
  • Information technology failures
  • Human error
  • Loss of key-person risk
  • Fraud
  • Business interruptions

Difference between Strategic and Operational Risks
            The main difference between strategic and operational risks is that strategic risks relate to the organization’s longer term place in, and relations with, the outside environment. Although some of them relate to internal functions, they are internal functions or aspects internal functions that have a key bearing on the organization’s situation in relation to its environment. Operational risks are what could go wrong on day to day basis, and are not generally very relevant to the key strategic decisions that affect a business, although some (for example a major disaster) can have a major impact on the business’s future.

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