The threat that a firm may no longer be able to operate as a going concern Show
What is Business Risk?Business risk is a component of total risk. Business risk represents the notion that a firm may experience events or circumstances that create a threat to its ability to continue operating. A firm’s management team is regularly tasked with making decisions about how to grow and operate a business. However, every decision about a new product offering, a new target market, or a potential merger (and many other examples) has the potential to fail and put the company’s ability to operate at risk. Key Highlights
Understanding Risk – Business Risks vs. Financial RisksBroadly speaking, risk can be split up into two main categories – financial risk and business risk. Financial RiskFinancial risk comes with the use of leverage (sometimes called gearing); it occurs when a company has a heavy reliance on debt as a funding source. Liquidity becomes a much bigger concern for a management team that borrows, as principal and interest payments must be made to service its debt obligations. A company that uses debt in its capital structure becomes susceptible to rising interest rates and is required to adhere to the terms of its various credit agreements. Financial risk represents the notion that a company’s commitment to meet debt service obligations, as well as potentially onerous covenants and reporting requirements, could push the firm into an event of default. Business RiskBusiness risk, on the other hand, is about internal and external forces that converge to create threats to a company and its management team. These threats could emerge from:
Company Life CycleUnderstanding the stage of a company’s life cycle can help analysts quantify the relative levels of business risk and financial risk. As illustrated in the image below, debt becomes a larger source of funding as a company progresses through its lifecycle (once the firm earns a healthy profit and has sufficient cash flow to service debt obligations). Early in a company’s life cycle, there’s no real opportunity to use leverage (or debt) – these businesses are typically equity-funded, precisely because business risk is very high. Early in a company’s life cycle, the product-market fit is unknown, the size of the target market may be unclear, barriers to entry may be high, and so on. The relative relationship between business risk and financial risk can be visualized as follows, with business risk being the orange line and financial risk being the blue one: Business risk is highest early in a firm’s life cycle, but quite low later on. Implicit in this is that if a firm achieves maturity, there is obviously a proven product-market fit and a viable business model. The inverse is true of financial risk. It’s low early on since debt is typically not available, then it gets progressively higher (peaking in the “decline phase” as sales decrease and margins begin to erode). Examples of Company-Level Business RisksCompany-level business risks are typically tied to a firm’s strategy and operations. Company level business risks include countless subcategories of potential threats; they include (but are not limited to):
Frameworks to Assess Business RiskThere are many tools and frameworks available to management teams and the analyst community that can help assess and quantify business risk. We’ve organized some of these into two buckets: Economy, Business Environment, and Industry
Company Level
More ResourcesThank you for reading CFI’s guide to Business Risk. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:
Who is a person who takes a risk to start a business?An entrepreneur is someone who takes a risk in starting a business to earn a profit whereas; entrepreneurship is the process of starting, organizing, managing, and assuming the responsibility for a business.
What is it called when you accept the risk of starting and running a business?“Entrepreneurship is accepting the risk of starting and running a business”.
What is a business owner who takes the risk of owning and operating a business?According to the Oxford Dictionary, an entrepreneur is “a person who organizes and operates a business or businesses, taking on greater than normal financial risks to do so.” This means that many entrepreneurs are just starting out with a business.
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