Q3: What are the different types of risks in Business Environment? Explain the methods of assessing them?

Ans: The term business risk refers to the possibility of inadequate profits or even losses due to uncertainties e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government policy, obsolence etc .Every business organization contains various risk elements while doing the business. Business risks implies uncertainty in profits or danger of loss and the events that could pose a risk due to some unforeseen events in future, which causes business to fail. For example, an owner of a business may face different risks like in production, risks due to irregular supply of raw materials, machinery breakdown, labor unrest, etc. In marketing, risks may arise due to different market price fluctuations, changing trends and fashions, error in sales forecasting, etc. In addition, there may be loss of assets of the firm due to fire, flood, earthquakes, riots or war and political unrest which may cause unwanted interruptions in the business operations. Thus business risks may take place in different forms depending upon the nature and size of the business.

Business risks can be classified by the influence by two major risks: internal risks (risks arising from the events taking place within the organization) and external risks (risks arising from the events taking place outside the organization).

There are basically seven types of risks that can be identified in business:

1.      Political Risk: political risk refers to the complications businesses and governments may face as a result of what are commonly referred to as political decisions—or “any political change that alters the expected outcome and value of a given economic action by changing the probability of achieving business objectives”. There are both macro- and micro-level political risks. Macro-level political risks have similar impacts across all foreign actors in a given location. While these are included in country risk analysis, it would be incorrect to equate macro-level political risk analysis with country risk as country risk only looks at national-level risks and also includes financial and economic risks. Micro-level risks focus on sector, firm, or project specific risk.

2.      Country Risk: refers to the risk of investing in a country, dependent on changes in the business environment that may adversely affect operating profits or the value of assets in a specific country. For example, financial factors such as currency controls, devaluation or regulatory changes, or stability factors such as mass riots, civil war and other potential events contribute to companies' operational risks. This term is also sometimes referred to as political risk However, country risk is a more general term that generally refers only to risks affecting all companies operating within a particular country. Or we can say that a collection of risks associated with investing in a foreign country is country risk. These risks include political risk, exchange rate risk, economic risk, sovereign risk and transfer risk, which is the risk of capital being locked up or frozen by government action. Country risk varies from one country to the next. Some countries have high enough risk to discourage much foreign investment.

3.      Government Effectiveness Risk: This risk is high. The divergent interests of the members of India’s coalition government have hindered the introduction of rapid reforms, and have led to concessions to groups affected by reforms, which have negated their impact. Although senior civil servants are generally professional, those further down the line are often resistant to change. The privatization program is continually hindered by vested interests not wishing to lose their power over state-owned companies.

4.      Legal and Regulatory Risk:  The risk that a change in laws and regulations will materially impact a security, business, sector or market. A change in laws or regulations made by the government or a regulatory body can increase the costs of operating a business, reduce the attractiveness of investment and/or change the competitive landscape. For example, utilities face a significant amount of regulation in the way they operate, including the quality of infrastructure and the amount that can be charged to customers. For this reason, these companies face regulatory risk that can arise from events - such as a change in the fees they can charge - that may make operating the business more difficult.

Another type of regulatory risk would be a change by the government in the amount of margin that investment accounts are able to have. While this is an unlikely change, if it were to be changed, the impact on the stock market would be material as this would force investors to either meet the new margin requirements or sell off their margined positions.

5.      Foreign Trade and Payments Risk: Risks in International Trade are the major barriers for the growth to the same. International trade has been a much debated topic. Economists have differed on the real benefits of international trade. The increase in the export market is highly beneficial to an economy, but on the other hand the increase in imports can be a threat to the economy of that country. It has been the worry of the policy makers to strike the right balance between free trade and restrictions. International trade can develop an economy, but at the same time certain domestic players can be outperformed by financially stronger multi nationals and forced to close down or get merged. Sometimes these multinational companies become so powerful, especially in smaller countries, that they can dictate political terms to the government for their benefit.

6.      Tax Policy Risk: This risk is moderate one. India’s tax system is heavily reliant on excise and custom duties. The tax system is complex, with numerous allowances  and surcharges. The govt. hopes to consolidate state sales taxes into a single value-added tax, but conflicts between the states and the centre have resulted in delays; VAT was set to be imposed in April 2003, then in June, but was delayed owing to protests by shop-owners. The VAT is introduced from 1^st April 2005. India’s tax system is susceptible to tax evasion, and the underground economy is estimated to be around half the size of the official economy. The highest rate of tax on profits for foreign companies is 41 percent including a surcharge.

7.      Financial Risk:  is an umbrella term for multiple types of risk associated with financing including financial transactions that include company loans in risk of default. Risk is a term often used to imply downside risk meaning the uncertainty of a return and the potential for financial loss. In addition to financial risks, there are five broad categories of investment risks known as five risks. In other words, financial risk is the possibility that shareholders will lose money when they invest in a company that has debt, if the company's cash flow proves inadequate to meet its financial obligations. When a company uses debt financing, its creditors will be repaid before its shareholders if the company becomes insolvent. 

Financial risk also refers to the possibility of a corporation or government defaulting on its bonds, which would cause those bondholders to lose money.

Methods of Assessing Environmental risk: Some of the following risk assessment methods are useful for both domestic and foreign firms.

1)      Expert Opinion: The traditional method of analyzing environmental changes relies on expert opinion. The firm seeks the subjective judgments of people who are well informed about the current state of the environment and its reading determinants. In this method, questionnaires designed to assess environment risk are sent ot acknowledged experts and their opinions, observations and comments are obtained. A variant of this method is the Delphi Technique in which a panel of experts is constituted and they are asked to give an assessment or prediction of risk, individually and separately. The process may be repeated and the final response is recorded as risk assessment.

2)      Checklists: These consist of a number of economic, social and political variables which affect the business environment and point to some risk element in it. The risk also contains elements relating to the various issues that the country is facing. This method gives a rough approximation of the business environment risk and the future outlook.

3)      Rating and Ranking Systems: This system is similar to the scoring system whereby country rating is done on the basis of a number of economic, financial, political and social parameters. Each of these parameters is weighted according to its importance in the total environmental risk. The weighted parameters are assigned scores according to preset guidelines and different sectors within a country are rated and ranked on a scale.

4)      Economic Methods: Such methods are complex and sophisticated and are used to quantify economic risk and related aspects. These methods are used both for estimation and forecasting. In such methods, we first identify the factors which affect environment risk and establish a model of their cause-effect relationship. The relationship is specified in a functional form usually stated as mathematical equation, which involves certain parameters whose values are estimated. In this approach it is possible to state, quantitatively, the strength of each variable that affects or determines business environment risk.