FINANCIAL AND CREDIT RISKS

What Is Business Risk?

Business Risk Defined

It’s no surprise that starting a new business venture or running a corporation comes with a certain degree of risk. However, the term “business risk” refers specifically to anything that could threaten a company’s financial health or lead to insolvency.

Business risks can come from a variety of sources – both internal and external – so it’s important to understand where and how your company may be most vulnerable to such dangers.

This article will explore the four main business risk categories, various ways they are created, and what you can do to protect your company from harm.

1 – Financial Risk

As the name implies, financial risk refers to anything that threatens an organization’s financial growth and profitability. More often than not, these business risks originate from sources outside the company, such as customers, suppliers, and legal regulations. For most companies, financial risks are inherent and widely accepted a just another part of doing business, but that doesn’t mean they shouldn’t be avoided. Here are a few types of financial risk to look out for:

  • Credit: Having too much debt – whether from bank loans, credit cards, or other sources – can put companies in a very precarious position and quickly lead to ruin.
  • Regulatory: Changing financial regulations can affect how lenders and creditors collect credit and calculate their bad debt reserves.
  • Profitability: Without properly managing cash flow and carefully balancing revenue with operational costs, a company’s profitability can be at risk. A recent study by Dun & Bradstreet found that growing profitably is a top concern for finance leaders facing business risk.

2 – Operational Risk

Operational risks include anything that disrupts a company’s ability to function, either temporarily or indefinitely. The risk can be as unpredictable as a natural disaster, or as sinister as theft. While most of these threats are beyond your control, your business can still take steps to prepare. Operational risks take many forms, including:

  • Fire, Theft, and Vandalism: Accidental fires, arson, and property crimes can destroy inventory, equipment, and structures, and leave businesses with hefty repair costs and lost productivity.
  • Natural Disasters: Without warning, hurricanes, tornadoes, and earthquakes can cause devastating damages, not just to physical structures and equipment, but they can also slow or completely halt operations.
  • Technology: Businesses rely on technology to continually improve productivity and quality of service, so a system failure of any kind can cause lasting damage. Furthermore, cybersecurity threats are always something to take seriously.
  • Labor: While your employees are your company’s greatest asset, they can also become a liability. Labor disputes might slow or stop work, and insider theft and embezzlement can cause significant financial pain.

3 – Compliance Risk

While certain industries, such as finance or pharmaceuticals, are more heavily regulated than others, nearly every business still faces some level of compliance risks. Here are some examples of compliance issues can threaten certain sectors.

  • Finance: Banks, credit unions, and other lenders face some of the most complicated and strict regulations due to the fact that they hold money and facilitate transactions across borders. Even one small misstep can have devastating consequences.
  • Healthcare: Patient privacy and protection are the reason there are such laws as the Health Insurance Portability and Accountability Act (HIPAA). If providers do not adhere to regulations, penalties can be harsh.
  • Manufacturing: There are several health, safety and environmental risks associated with manufacturing, and these can affect both employees and consumers alike. Manufacturers are expected to comply with strict government safety guidelines for workers and products.
  • Technology: New legislation like COPPA, the Children’s Online Privacy Protection Act, is becoming more of a concern for just about any company with a website. Any web-based financial technology (fintech) businesses may also have to comply with additional regulations.

4 – Global Risk

Regardless of what industry you’re in, conducting business with other countries or on foreign territory comes with its own unique set of risks. Some global risks to be aware of include:

  • Economic: Doing business abroad can be risky, especially in countries whose economies are threatened by changing geopolitical environments.
  • Third-Party: Working with foreign, third-party vendors and suppliers can pose a risk of tainted by bribery and corruption issues. The United States government has been aggressive in combating these types of financial crimes.
  • Cross-Border Compliance: There are also several anti-corruption and tax laws that apply to any transactions that originate or end within the U.S., regardless of where the company is based. This means that any business that wants to have a presence in the country needs to comply with these regulations.

Mitigating Business Risk

Once you’re aware of the types of business risk that may apply to your company or industry, it’s important to put specific risk management processes and procedures in place that will monitor your customers, vendors, suppliers, partners, and employees and help analyze, or calculate, your level of risk.

For instance, if you conduct business overseas, or if you’re planning to, it’s vital that you stay current on foreign market data and trends. Companies like Dun & Bradstreet provide a variety of global risk analysis tools to help companies calculate risk levels in any country across the globe.

When it comes to financial risk, companies can use their financial statements to calculate risk. There are several different formulas, or ratios, that can be used. Here are three common financial statement ratios:

Solvency Ratios - Quick Ratios

The quick ratio, sometimes called the "acid test" or "liquid" ratio measures the extent to which a business can cover its current liabilities with current assets readily convertible to cash. Only cash and accounts receivable would be included, as inventory and other current assets would require time and effort to convert into cash. A minimum ratio of 1.0 to 1.0 ($1 of cash receivables to $1 current liabilities) is desirable.

Profitability Ratios - Return On Sales (Profit Margin)

Return on sales (profit margin) ratio measures the profits after taxes on the year's sales. The higher this ratio, the better your business is prepared to handle downtrends brought on by adverse conditions.

Efficiency Ratios - Sales to Inventory

Sales inventory ratio provides a yardstick for comparing stock-to-sales ratios of a business with others in the same industry. When this ratio is high, it may indicate a situation where sales are being lost because a concern is understocked and/ or customers are buying elsewhere. If the ratio is too low, this may show that inventories are obsolete or stagnant.

For more information about business risk management and tools you can use to protect your business, explore Dun & Bradstreet’s Finance Solutions.

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