By Harshvardhan, the Subject Matter Expert at Edumarz
Solution: The term ‘business risk’ refers to the possibility of inadequate profits or even losses due to uncertainties or unexpected events. For example, demand for a particular product may decline due to change in tastes and preferences of consumers or due to increased competition from other producers. Lower demand results in long sales and profits. In another situation, the shortage of raw materials in the market may shoot up its price. The firm using these raw materials will have to consequently pay more to the suppliers for buying them. As a result, the cost of production may increase which, in turn, may reduce profits.
Business organisations always face two types of risk:
- Speculative Risk– Speculative risks involve both the possibility of gain, as well as, the possibility of loss. This type of risk can go either way. Speculative risks arise due to changes in market conditions, including fluctuations in demand and supply, changes in prices or changes in fashion and tastes of customers. Favourable market conditions are likely to result in gains, whereas, unfavourable ones may result in losses.
- Pure Risk– Pure risks involve only the possibility of loss or no loss. The chance of fire, theft or strike are examples of pure risks. Their occurrence may result in loss, whereas, non-occurrence may explain the absence of loss, instead of any gain.