The term risk can be defined as any circumstance where we are moved to make a particular decision/action that we are not certain of the outcomes.
Every day, we must take risks in all aspect of life and risk cannot be eliminated completely, but it can only be managed.
As entrepreneurs, starting a business is itself a risk since the future is unknown. But how can we ensure that we are on the safe side and manage the risks to manageable levels?
Effective risk management can only be achieved when entrepreneurs get to understand what type of business risks they are likely to face in their daily business operation.
Risks if not properly managed can cause a great short-term or long-term impairment to your business cash flows/earnings. The following are the common business risks that entrepreneur face and how they can be mitigated.
1. Market risks
Market risks occur in the external business environment. The business is subjected to price fluctuations of commodities, interest rates or exchange rates. The changes in commodity prices will affect the projected cash flows of your business.
Variations in the interest rates and exchange rates also have an adverse effect on businesses operating in the financial sectors, and it influences their lending rates.
Diversification can mitigate market risks especially for those operating in commodity markets. Venturing into various product lines that do not have a high correlation will ensure that your business will withstand the risks waves.
If you operate in the financial sector, engaging experts will ensure that your business risk volatility is determined, and they will advise you accordingly.
2. Liquidity risks
A liquidity risk occurs as a result of business transactions where liabilities from creditors and investors are not honored in time. Liquidity risks are evident in situations where the business experience low trading volumes and large bid-ask prices (where the price of a commodity falls below its fundamental value, or it takes a longer period of time for it to sell).
Creditors and investors may demand their money back if there is prove that the business is likely to incur losses that may threaten its solvency. Therefore, your business can be subjected to assets liquidation at distress prices which can lead to substantive losses.
To mitigate the liquidity risks, entrepreneurs are required to have a better understanding of asset liability management, market clearing mechanism, and optimal trade excursions.
3. Operational risks
Operational risks are experienced in day to day business activities. They are risks of losses that might occur due to physical catastrophe, human error, technical failure, and fraud and process errors during daily business operations.
The common methods of mitigating operational risks include; hedging, risk transfer, and risk sharing.
4. Credit risks
A credit risk emanates from the credit side where the counter party may fail to honor it obligations either in full or partial as per the debt agreement. Credit risks can pose a great threat to your business financial position.
In order to mitigate credit risks, you can consider transferring the risk to a third party through invoicing. Credit risks can also be managed by reducing the rate at which your business is subjected to credit risk exposure through risk avoidance.
5. Business risks
Business risks arise as a result of changes in the business plan model. It occurs in the internal business environment, and it affects the business operations which determines the competitive advantage of the business as well as it adoption to modern technology.
Business risks can be managed through risk control, and every entrepreneur should ensure that proper business strategies are put in place so as to define the business direction either in short-term or long-term processes.
The bottom line:
It is important to note that risks in business cannot be eliminated, transferred or avoided completely. If there were no risks to be taken, there could be no business!! Risks can only be managed at optimal levels.