What is the Definition of Risk in Business?
Every organization faces risk every day. Whether you’re managing a corporation, a government agency, a not-for-profit or a public institution, business risk is something that must always be factored into organizational decision-making.
In this article, we’ll explain what business risk is, and outline strategies you can implement in order to identify, manage, and mitigate these risks. In doing so, you can focus on achieving your organization’s goals without worrying about the hazards that could potentially damage your operations and reputation.
What is risk in business?
Risk in business is exposure to something that poses a threat to an organization’s ability to achieve its goals and it can lead to falling revenue, lost profits, a damaged reputation, legal proceedings and – ultimately – failure.
These risks can arise internally such as employee dishonesty, ineffective management or unproductive internal processes. But they can also present themselves externally, whether through legislative change or unexpected disruptions in the global economy (such as a pandemic).
Despite organizations facing hundreds of risks daily, there are several ways to mitigate them and having in place a robust risk management strategy is essential to any business.
Types of business risks
Below, we’ll outline the types of risk that your organization may face during its day-to-day operations. Many of these risks may be more prevalent in some organizations than others, and the level of importance placed on them will often depend on the organization’s goals, structure and industry.
Compliance risk refers to an organization’s exposure to financial loss as a result of failure to comply with regulations and standards usually set by government. Some examples of compliance risks include:
Illegal practices. Legal compliance requires organizations to abide by laws. Compliance risks will arise from organizational practices that break those laws. Money laundering, fraud and embezzlement are examples.
Privacy protection breaches. Privacy laws are strict in most parts of the world. A data leak can give rise to a significant privacy breach, resulting in the imposition of penalties or fines by government.
Work health and safety. Companies are legally required to follow specific safety laws, especially in industries such as construction, mining and transport. Failure to comply with strict safety standards, resulting in the injury or death of an employee, may give rise to significant penalties including prosecutions, fines and even imprisonment.
Legal risks are related to compliance risks, but they extend further than violating a law. It includes any legal exposure that arises in business. Some examples of common legal risks include:
Contractual risks – when an organization enters into a contract, they are exposing themselves to risks. Legal risk arises if a party to the contract fails to fulfil their obligations resulting in breach of contract with the potential for legal accountability or litigation.
Public liability risks – these can occur if, for example, a customer slips and falls, injuring themselves on your premises and decides to commence legal proceedings against you for damages.
Regulatory risks – these are related to compliance risk and can occur, for example, if a regulator withdraws, suspends or cancels a licence the organization needs to operate in a particular industry leading to cessation of operations.
Risk of disputes – these are the result of handling disputes with customers, clients, stakeholders and members of the community. These can lead to litigation and harm to the reputation of you organization.
Strategic risk arises when an organization fails to properly execute its business strategy, or when the strategy itself is flawed. This can include:
- Making poor strategic decisions
- Lack of clear vision by senior leadership
- Failing to respond to a changing economic environment
- Introducing new products and services that fail to gain traction
- Unsuccessful mergers or acquisitions
Operational risk arises from a variety of sources including employee risk, flawed internal processes, or external events such as floods decimating an organization’s physical infrastructure. These are ‘ground level’ risks – and are therefore different from ‘high level’ strategic risks.
A notable example of an operational failure occurred in 2012, when large international bank HSBC was fined by the U.S. Justice Department because the company’s anti-money laundering team did not stop money laundering from occurring in Mexico. HSBC entered into a Deferred Prosecution Agreement and agreed to pay USD $1.256 billion.
Financial risk is one of the most important risks that a business must consider. It refers to any risk that can cause a financial loss to an organization, such as not having enough cash to meet its debts or make repayments on its loans. Organizations that have entered into debt financial arrangements will typically have a higher level of financial risk than others.
One example of financial risk includes liquidity risk. These risks eventuate when a business cannot convert assets into cash in order to meet financial obligations. Another type of financial risk is currency risk, which can result in a loss due to the change in price of one currency in relation to another.
Looking closer at a currency risk scenario, let’s say a Canadian company agrees to sell products to a French company for a certain amount of euros. A sudden drop in the exchange rate could result in that Canadian company losing revenue.
Cybercrime is one of the biggest risks to business. Data breaches, network hacks, ransomware attacks and system shutdowns concern every organization.
According to Statistics Canada, in 2019, approximately 21% (one-fifth) of Canadian businesses reported being affected by a cyber incident. Canadian businesses also spent $7 billion that year on cybersecurity measures to prevent, identify and recover from cyber incidents.
Reputational risks refer to damage that can result in an organization being poorly perceived by the public. For example, several Canadian mining companies faced severe reputational risk in when they were charged in 2019 with human rights violations in Canadian courts.
How to manage risks in your business
Risk management is an integral part of running any organization, no matter its size. Below are the steps every organization should take when developing a risk management strategy.
Assess the processes in your organization
The first thing to successfully identify business risk is to undertake a thorough analysis of your organization’s current processes. This can involve undertaking a “SWOT” analysis, as follows:
- Strengths: detect what your organization’s strengths are, so you can learn what it is doing well (and what you can strengthen).
- Weaknesses: identify areas your business could improve upon. This will allow you to develop strategies to turn those weaknesses into strengths.
- Opportunities – conduct research into your industry and market, so you can identify room for growth.
- Threats – assess the various internal and external factors that threaten the viability of your organization, so you can make sure they do not escalate into something catastrophic.
Analyze unique and common risks
Once you’ve developed a strong understanding of your business’ current processes, the next step is to look at both risks that are common to other organizations in your industry and also the risks the risks that are unique to your organization. You can do this by anonymously obtaining feedback from your employees and managers at all levels to identify risks and know where they are arising from.
Create a risk report
Create a record of the risks identified. Your risk report should include the following:
- Risk register – this identifies each risk your organization faces – including their probabilities, impact and source.
- Corrective action plans – these are the plans you will put in place to mitigate the risks identified in your risk register.
Monitoring and review – your report should include timelines for implementing risk mitigation plans with a regular review cycle. It is critical to keep up to date on the law and current trends.
You should keep current of changes to the law or regulation that may affect your industry. This will allow you to plan ahead and avoid risks to your organization down the road.
Case Example: The Digital Charter Implementation Act 2022
An example of a new risk that businesses across Canada may face is the increased privacy protection for consumers introduced by the Digital Charter Implementation Act 2022.
This legislation will reportedly strengthen Canada’s privacy law as it applies to the private sector. The Act is said to give Canada’s Privacy Commissioner broad powers, including the power to stop a company from using personal information.
The new law also establishes fines for companies who are not compliant, including penalties of $25 million or up to 5% of a company’s global revenue (whichever is higher) in the most serious cases.
These may be new risks that organizations in Canada will need to consider. Seek professional legal advice to learn how the law applies to you.
Hire experts to assist you
Professional risk management consultants can help your organization navigate the intricacies of compliance, legal, financial and reputational risks faced by your organization.
Ensure your organization has the appropriate insurance policies in place to help you manage your organizational risk. Contact an experienced insurance professional at Axxima who can help you ensure you have the right coverage for your business such as:
- Un cyber insurance policy can cover the costs associated with a cyber incident (such as the costs of incident response and recovery).
- Un product liability policy can protect your organization if your products cause personal injury or damage to a third party.
- Un professional liability policy can protect your business if your services have caused harm to a third party. This is also known as errors and omissions
- Un business property and contents insurance policy can cover you in case your business becomes a victim of theft or property damage.
We can help you identify your business risks, and craft tailored insurance policies to make sure you have the right coverage for your organization.