Business risk - limits and components
| Author | University Leturer Ph.D. Elena Druica/University Professor Ph.D. Viorel Cornescu/University of Bucharest |
| Pages | 1-13 |
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The MacMillan Economy Dictionary1 incorporates the concept of business risk, which is somehow ambiguous, into the corporate risk, defined as the total risk occurred in an economical activity. It is further suggested that it is the matter of an agreed vision over the two major types of risk it comprises, i.e.: the financial risk, arising from financing by means of a loan and the economical risk, representing a fundamental risk of the current activity in a company. Another opinion is described in the Economy Dictionary2, where the concept of business risk is referred to in close connection with the concept of profit3. Given the fact that under this vision the profit is viewed as a synthetic expression of the efficiency in the activity of any business entity, the major objective of such entities is connected with the profit maximization and the business risk is deduced to represent the risk of not obtaining and/or not maximizing the profit. According to the opinion of Hirschey and Pappas4, the business risk represents the "chance" of loosing, associated to a managerial decision and it is directly connected with the idea of product demand variation and under the conditions directly depending on the costs level. Moreover, Petru Prunea5 associates the business risk with the risk manifested in the organizational development process, in respect with quality increase, products and capacity diversification, or with the use of improved technologies, leading to a bigger profit. The Electronic Investments Encyclopaedia6 provides that the business risk is the risk for a company to not have the adequate cash-flow needed in order to meet the current expenses for the purpose of being operational; it is stipulated that there are two components, namely: the financial risk connected to the loans and the risk arising from the economical environment. McGladery7 - a Risk Consultancy Company uses a more general wording, describing the business risk as the event or action having adverse effects over the company's stability in its pursuit of meeting its objectives and strategies.
Although the few examples of approach use particular visions and wordings in order to describe the business risk, it is our opinion that such views have a number of commune features, which we are to synthesize in the following. In any company, the occurrence of a risk is a potential source of issues. An "issue" represents the difference between the recorded result and the intended one or, in other words, the distance between the effective result and the initial objective. To the extent in which it is accepted that obtaining, upholding and maximizing the profit is the implicit objective of the economical activity, the similitude can be noticed between the vision stated in the Economy Dictionary and the vision of the McGladrey consultancy company. No business entity will carry out its activity randomly: in order for its objectives to be achieved, the business entity needs coherent, functional and efficient strategies. In order to fulfill the said strategies, favorable conditions are needed and, most of all, they
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need to be designed in accordance with the objectives (ability is needed for this scope). Therefore, between strategy and objectives an intrinsic relation exists and the business risk under the view of Hirschey and Pappas is somehow similar with the other two above mentioned opinions. The descriptions in the MacMillan Dictionary and the Electronic Encyclopedia actually suggest the same idea and if we agree that a company's activity is grounded on the universal engine which is the financial aspect, then we need to accept that the implementation and carrying out of the strategies and the achievement of the objectives are actions which cannot be performed without an adequate cash-flow. At last, the vision of Petru Prunea provides us with several company general strategies and objectives, either depending on conjunctures or permanent and is also in line with the general opinion on the business risk.
As it can be noticed, it has not been our intention to emphasize that the approaches of various authors are incomplete, and we have not stressed the differences between their visions. The fact that their opinion proved to be convergent has nothing to do with the fact that they are not identical. In order to describe the business risk, it is essential the idea of aggregation, of total risk undertaken by the company and such aspect should be a disturbing one. In order to discuss this risk, we need to have a view on the risk assessment, and the correctness in quantifying an agreed measure is such a difficult matter, that the identification of small semantic differences between the descriptions of the business risk made by various authors could be at the most as important as some insignificant gossips.
Therefore, it is more than necessary to sort the components which are to be analyzed, and such separation shall be performed upon the terms already mentioned in the descriptions above. Thus, we operate a distinction between a risk regarding the internal activity of the company and a risk of financial nature, which are to be referred to in the following. It is important to underline from the very beginning that we attempt to create a limit as strict as possible between the two said risk categories, because in view of the aggregate model to be set up, we become interested in ensuring - to the possible extent - that the occurrence and implications of the events in the two categories are independent. Of course we cannot certainly assert that in the functioning of an organization there are phenomena which are entirely independent of one another, but we can establish a limit between the phenomena which are strongly connected or very strongly connected and those which are insignificantly connected to each other. We felt the need of making such clarification because the investments made by an organization are grounded on initiatives, decisions, in short on internal activities, whilst the risks that might occur are of financial nature. Also, the assessment of the demand is an organizational activity, and by overestimating it losses may be generated from the expected incomes, hence financial damages can arise. However, in the following limitation the two aspects are to be described distinctly. We need to establish a series of risks which represent a cause for each of the two major categories generating business risk, and the fact that we will attempt each time to express the results in money is only an initiative aimed to help in setting up the model for assessing the total risk.
Regardless whether the organization provides goods, services or information, its activity is grounded on general elements which in the economic sciences are referred to the same, notwithstanding the nature of the products. These elements are demand, offer, a process of making the offer - irrespective whether it is a matter of actual production or of creating it by methods which do not imply equipments, assembly plants, a used technology, a selling process etc. Therefore, we are to include in this first risk category all those events which can generate problems in respect with achieving the objectives set out by the organization under this specific activity.
Potential problems might be encountered in this regard in attracting and appointing human resources, in establishing the offer, in assessing the demand,
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in deciding upon the utilization of the technologies, in the relations with the competitors or in obtaining the intended sales level. There can also be included here the problems which might occur in result of the questionable quality of the product or consequent to the price fluctuations, as well as many other situations or events that might influence the obtaining, maintenance and maximization of the profit. In other words, we have described enough possibilities in order to persuade that a more clear distinction should be made. Unless we make a clear distinction between the cause, means of manifestation and effects of the risk affecting the profit, the initiative of identifying such risks, as well as any ulterior attempt of measuring them, will be undoubtedly unsuccessful Let us take an example and discuss the implications of a potential "risk for the raw materials suppliers to not fulfill their contractual obligations in due time".
The causes for such situation could be separated into three major types:
a) Regarding the supplier directly:
> Unreliability; > Accidents during the transportation; > Damage of the raw materials and of the materials in the supplier's deposits, caused by irresponsible conduct of the employees.
b) Regarding the relationship between the supplier and the producer:
> Breach by the producer of one or more contractual clauses, which might free the supplier of its obligation of fulfilling the contractual terms or might lead to the termination of the contract;
> Refusal from the producer to receive raw materials or materials of inappropriate quality etc.
c) Independent of both the supplier and the producer:
> The raw materials or materials are stolen; > The raw materials or materials are damaged due to accidental causes: fire, earth quake, floods, landslips etc.
Regarding the means of manifestation, apparently there is nothing to discuss, because it is a clear matter: the raw materials and materials do not reach the producer upon the contractual term. However, there can be taken into account several possibilities, on which the effects of the occurred issue will be dependant. The distinction will be made in this case upon the delay...
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