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Calculating Risk for Businesses


Business Risk: Anything that threatens a company's work to meet its target or achieve its financial aim is called business risk. These risks come from a variety of sources, so it's not always the company head or a manager to blame. Instead, the risks may come from different sources within the firm or they may be external—from regulations to the overall economy.



While a company may not be able to shelter itself from risk completely, there are different ways to protect itself from the effects of business risk, primarily by adopting a risk management strategy.

Types of Business Risk
·         Compliance Risk: Compliance risk is that risk arises in industries and sectors which are highly regulated with laws. The FMGC, for example, must adhere to the three-tier system of distribution, where a wholesaler or franchise partner is required to sell product to a retailer, who in turn sells it to consumers. Manufactures cannot sell directly to retail stores.
  •          Strategic Risk: Strategic risk arises when a business does not operate according to the business model or plan. Every business has unique business model. A company's strategy becomes less effective over time and it struggles to reach its defined goals, if not follow’s his model as per the customer behaviour.

·         Operational Risk: The third type of business risk is operational risk. This risk arises from within the corporation—when the day-to-day operations of a company fail to perform. Any time a company's reputation is ruined, either by one of the previous business risks or by something else, it runs the risk of losing customers base on a lack of brand loyalty.

Business risk is tied to a company's fixed costs. Fixed costs always have to be paid, no matter what the company is in profit or loss. The higher the level of a company's fixed costs, the higher the business risk. Below is financial ratio that a business owner used to calculate risk of business:

·         Financial Leverage: The financial leverage ratio measures the amount of debt held by the business firm that they use to finance their operations. Debt creates an additional business risk to the firm or company if income varies because debt has to be serviced. In other words, if a company uses debt financing, they have to pay interest on the debt no matter what their income. The financial leverage ratio measures that affect the business. We can also say that it measures the financial risk of the business. The formula is:
            Financial Leverage = Operating income/Net income.  
·         Operating Leverage Effect: You use (OLE) ratio to measure how much income will change given a percentage change in sales volume. The more fixed assets the firm has, the more the change will be. The formula for the operating leverage effect ratio is:
     Contribution Margin Ratio/Operating Margin
·         Combined Leverage Ratio: Although business firms most often calculate operating leverage and financial leverage separately, they can and should also calculate the effect of both on the firm. They can use the combined leverage ratio to do this. You simply put together the operating leverage ratio, which measures business risk, and the financial leverage ratio, which measures financial risk, to get combined leverage, which measures total risk. The formula is:
Combined Leverage Ratio = Operating Leverage Ratio * Financial Leverage Ratio
·         Contribution Margin Ratio: The contribution margin ratio is the contribution margin as a percentage of total sales. The contribution margin is calculated as sales minus variable costs. The contribution margin ratio is calculated as:
Contribution Margin/Sales = 1 - variable costs/sales
How to Avoid Business Risk

Below are the steps you can follow to avoid business risk:

·         Identify Risk: Almost any business has to identify & analyse business risk.
·         Record the Risk: Once company has come up with a plan to deal with the risk, it's important to document each & every document just in case the same situation arises again.
·         Strategy Management: This is an important factor in any business plan to come up with a strategy, that the company better prepared to deal with risks as they face in prese current. The plan should have tested ideas and procedures in place in the event that risk presents itself.

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