What Are Risk Factors?
Risk factors in Business are constituents, circumstances, or causes, responsible for interruption, or, disrupting the business activities or operations, expectations, plans, objectives, or strategies of a business or an investor along with hampering the business’s ability to extend the promised results to the stakeholders because of the uncertainties, and impact of unforeseen or assumed risks.
Risk factors denote elements which could hamper the organization’s growth or its stated or expected objectives. The objectives could be numerous depending upon business to business, and subsequently, the number of risk factors falls in the same tandem.
Types of Risk Factors in Business
As already mentioned above, examples of risk factors vary from business to business, but objectively, and generally, we could divide them into two categories:
#1 – Internal
Risk factors are generated because of the company’s operation is widely known as internal risk factors. These are inherent to the organization and its activities. As these risks are created in an organization, to some extent, these could be forecasted and mitigated with greater ease in comparison to the external risk factors. So, its relatively easy to counter, alleviate, or reduce the risks originating within the entity. It is broadly divided into three following types:
- Sometimes risks are generated because of the human capital of the organization. Few mentions could be incompetent staff, labor shutdowns, unethical practices followed by employees, dishonesty, embezzlement of moneyEmbezzlement Of MoneyEmbezzlement refers to the act of secretly taking, withholding, or misappropriating money or other asset that is kept, maintained, or placed under an individual's responsibility by the company for which he or she works., etc.
- Over time, digitalization has access to almost all spheres, and the risk faced because of technology is paramount. Every organization which is equipped with technology in any way could face challenges such as data theft, hacking, inefficient workings of software or apps in place, etc. These risks could lead to inefficiency or lack of productivity, and in many cases, it could lead to global embarrassment and loss of goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price..
- Last but not least, a risk also persists regarding the physical assets of the business. Irrespective of digitization or technological advancements, an organization would require some physical assets to manage its day-to-day activities. If tangible or intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. fall prey to irregularities, it also causes deep suffering. The significant risks perpetrated in this area could be loss, theft, or damage to assets, leading to interruption, halt, or shutdown or business activities or business.
#2 – External
Another type of risk generated from outside of an organization is known as external risk factors. These could make from any sources such as from the competition, economy, nature, and policies of the govt. External risks are challenging to anticipate due to their unique character, and similarly, the countermeasures are severe. A few are mentioned below:
- Economic Risks: When the whole economy is down turning, it is tough to keep the businesses in good shape. In depression or slanting economy, consumer spending lowers, employment takes a hit, investments, and spending reductions. Likewise, it creates a circular effect by affecting all businesses in the nation.
- Natural Risks: Risks that originated from natural causes are also severe and unpredictable. It could affect the business in multiple ways such as operations, damage to physical assets, closure of stores hit by natural calamities, etc. It is considered as one of the biggest threats, but, fortunately, adequate insurance could provide excellent support in these situations.
- Political Risks: Every govt has its policies and agendas in place. A business could get affected by the govt. Policies about finance, taxes, import/export, tariffs, etc. Though risks emanating from political events are entirely predictable as the parties mention their agendas in the election manifesto or a general idea about the upcoming policies are available in the public domain. Some insurance plans could protect businesses from risk initiating from political uncertainties, war, import/export regulations, etc.
How to Calculate Risk Factor in Business?
In some cases, such as risk factors related to natural calamities and economic issues, it is complicated to assess the damage laden by risk factors. Still, in other cases, it could be devised. Businesses generally have a dedicated department taking care of issues arising from various types of risks. The calculation of impacts by a risk factor could be done by assuming a probability of such an event happening by multiplying it with the expected damage entailed by the risk factor. For example, the assessment of loss expected from a fire to the factory of an entity could be calculated by a 10% chance (assumed) of happening multiplied by $10 million value of a property.
Risk Management in Business
Every business has a chance of facing risk or another. The management or risk managersRisk ManagersA risk manager takes care of the financial risk management of an organization by proactively identifying and analyzing potential risks along with the development of preventive measures to either entirely remove or minimize these risks. take into account any policies and procedures to actively manage the risks. The most popular way of managing risks are given below:
- Identification of Risk
It depends upon the business and the risk factors. For example, if we calculate risk from a Fire, we will check the history of fire in the neighborhood, type of material produced (could be inflammable), the proximity of electric poles, or powerhouses, etc. A risk manager is a specialized person to do such an audit and furnish a report to management that which areas are prone to accidents. Similarly, there are various ways in which risks could be identified from business to business.
- Expected Impact of the Risk
The impact is calculated by assuming the probability of risk materialization, as per the expectations, such as a high chance of occurring, or very little chance of happening, along with the expected damage, the impact by a risk factor could be calculated.
- Risk Mitigating Policies
In case of the risk materializing, the risk mitigation process gets activated, and the impact of damage gets lowered. Being adequately insured, having multiple backups of data, etc. are few measures to reduce the impact of the risk materialized.
- Risk Prevention
Preventive measures include making specific policies for asset safety, work manuals, general weather forecasts, adequate checks on financials, etc. could be used to prevent risk from actualizing.
- Risk Tolerance
Sometimes, when the impact of the risk factors is insignificant or petty. In such cases, there is no point in addressing such risks or to prepare plans to avoid them. So, in these cases, the risk is toleratedRisk Is ToleratedRisk tolerance is the investors' potential and willingness to bear the uncertainties associated with their investment portfolios. It is influenced by multiple individual constraints like the investor's age, income, investment objective, responsibilities and financial condition. by the organizations.
In the end, all the businesses are laden with risks arising from multiple risk factors severely impacting the entities. Organizations do foresee, plan, and make arrangements to prevent and correct the issues and damages caused by several risk factors.
This has been a guide to what are risk factors in business and its definition. Here we discuss types and how to calculate risk factors along with its management. You may learn more about financing from the following articles –