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What Is Business Risk?

Understanding business risk, reducing business risk, the bottom line, business risk: definition, factors, and examples.

Business risk is the exposure a company or organization has to factor(s) that will lower its profits or lead it to fail. Anything that threatens a company’s ability to achieve its financial goals is considered a business risk .

There are many factors that can converge to create business risk. Sometimes it is a company’s top leadership or management that creates situations where a business may be exposed to a greater degree of risk.

However, sometimes the cause of risk is external to a company. Because of this, it is impossible for a company to completely shelter itself from risk. However, there are ways to mitigate the overall risks associated with operating a business ; most companies accomplish this by adopting a risk management strategy.

Key Takeaways

Business risk is any exposure a company or organization has to factor(s) that may lower its profits or cause it to go bankrupt.
The sources of business risk are varied but include changes in consumer taste and demand, the state of the overall economy, and government rules and regulations.
Risk can be created by external factors that the business doesn’t control, as well as by decisions made within the company’s management or executive team.
While companies may not be able to completely avoid business risk, they can take steps to mitigate its impact, including the development of a strategic risk plan.

Xiaojie Liu / Investopedia

When a company experiences a high degree of business risk, it may impair its ability to provide investors and stakeholders with adequate returns. For example, the chief executive officer (CEO) of a company may make certain decisions that affect its profits, or the CEO may not accurately anticipate certain events in the future, causing the business to incur losses or fail.

Business risk is influenced by a number of different factors, including:

Consumer preferences, demand, and sales volumes
Per-unit price and input costs
Competition
The overall economic climate
Government regulations

A company with a higher amount of business risk may decide to adopt a capital structure with a lower debt ratio to ensure that it can meet its financial obligations at all times. With a low debt ratio, when revenues drop, the company may not be able to service its debt (and this may lead to bankruptcy ). On the other hand, when revenues increase, a company with a low debt ratio experiences larger profits and is able to keep up with its obligations.

To calculate risk, analysts use four ratios: contribution margin, operation leverage effect, financial leverage effect, and total leverage effect. For more complex calculations, analysts can incorporate statistical methods.

Business risk usually occurs in one of four ways: strategic risk, compliance risk, operational risk, and reputational risk .

Types of Business Risk

Strategic risk.

Strategic risk arises when a business does not operate according to its business model or plan. When a company does not operate according to its business model, its strategy becomes less effective over time, and the company may struggle to reach its defined goals.

For example, imagine ABC Store is a big box store that strategically positions itself as a low-cost provider for working-class shoppers. Its main competitor is XYZ Store, which is seen as a destination for more middle-class consumers. However, if XYZ decides to undercut ABC’s prices, this becomes a strategic risk for ABC.

Compliance Risk

The second form of business risk is compliance risk, sometimes known as regulatory risk. Compliance risk primarily arises in industries and sectors that are highly regulated. For example, in the wine industry, there is a three-tier system of distribution that requires wholesalers in the United States to sell wine to a retailer, which then sells it to consumers. This system prohibits wineries from selling their products directly to retail stores in some states.

However, many U.S. states do not have this type of distribution system; compliance risk arises when a brand fails to understand the individual requirements of the state in which it is operating. In this situation, a brand risks becoming noncompliant with state-specific distribution laws and may face fines or other legal action.

Operational Risk

The third type of business risk is operational risk . This risk arises from within the corporation, especially when the day-to-day operations of a company fail to perform.

For example, in 2012, the multinational bank HSBC faced a high degree of operational risk and, as a result, incurred a large fine from the U.S. Department of Justice when its internal anti-money laundering (AML) operations team was unable to adequately stop money laundering in Mexico.

Reputational Risk

Anytime a company’s reputation is ruined, either by an event that was the result of a previous business risk or by a different occurrence, it runs the risk of losing customers and its brand loyalty suffering. The reputation of HSBC faltered in the aftermath of the fine it was levied for poor anti-money laundering practices.

Business risk cannot be entirely avoided because it is unpredictable. However, there are many strategies that businesses employ to cut back the impact of all types of business risk, including strategic, compliance, operational, and reputational risk.

The first step that brands typically take is to identify all sources of risk in their business plan . These aren’t just external risks—they may also come from within the business itself. Taking action to cut back the risks as soon as they present themselves is key. Management should come up with a plan to deal with any identifiable risks before they become too great.

Finally, most companies adopt a risk management strategy . This can be done either before the business begins operations or after it experiences a setback. Ideally, a risk management strategy will help the company be better prepared to deal with risks as they present themselves. The plan should have tested ideas and procedures in place in case risk presents itself.

Once the management of a company has come up with a plan to deal with the risk, it’s important that they take the extra step of documenting everything in case the same situation arises again. After all, business risk isn’t static—it tends to repeat itself during the business cycle. By recording what led to risk the first time, as well as the processes used to mitigate it, the business can implement those strategies a second time with greater ease. This reduces the time frame in which unaddressed risk can impact the business, as well as lowering the cost of risk management.

What Are the 4 Main Types of Business Risk?

The four main types of risk that businesses encounter are strategic, compliance (regulatory), operational, and reputational risk. These risks can be caused by factors that are both external and internal to the company.

Why Is Risk Management Important in Business?

Businesses face a great deal of uncertainty in their operations, much of it outside their control. This uncertainty creates risk that can jeopardize a company’s short-term profits and long-term existence. Because risk is unavoidable, risk management is an important part of running a business. When a business has a thorough and carefully created risk management plan in place, and when it is able to iterate on that plan to deal with new and unexpected risks, the business is more likely to survive the impact of both internal and external risk.

What Are Internal Risks That Can Impact a Business?

Internal risks that can impact a business often come from decisions made by the management or executive team in pursuit of growth. These decisions can create physical or tangible risks. For example, on-site risks such as fires, equipment malfunctions, or hazardous materials can jeopardize production, endanger employees, and lead to legal or financial penalties. Policies that guarantee a safe working environment would, in this instance, be an effective strategy for managing internal risks.

In business, risks are factors that an organization encounters that may lower its profits or cause it to fail. Sources of risk can be external, such as changes in what consumers want, changes in competitor behavior, external economic factors, and government rules or regulations. They can also be internal, such as decisions made by management or the executive team.

No company can completely avoid risks, especially because many risk factors are external. However, businesses can put risk management strategies into place. These strategies can be used to reduce risk and to mitigate the impact of risks when they arise. By documenting the sources of risk and creating a strategic plan that can be repeated, businesses can reduce the overall impact of risk and deal with it more efficiently and effectively in the future.

National Alcohol Beverage Control Association. “ Alcohol Regulation 101: Three-Tier System .”

National Alcohol Beverage Control Association. “ Alcohol Regulation 101: Structure of U.S. Alcohol Regulation .”

U.S. Department of Justice, Office of Public Affairs. “ HSBC Holdings Plc and HSBC Bank USA N.A. Admit to Anti-Money Laundering and Sanctions Violations, Forfeit $1.256 Billion in Deferred Prosecution Agreement .”