A business risk is a factor that can be generated in the external or internal environment of our organizations and that materializing can make our business not achieve its objectives. A business risk can affect the continuity of a company.
Many organizations have not defined an Internal Control System focused on risk management, which does not allow them to respond adequately to the materialization of business risks.
The task of the company’s management is to identify significant business risks (high probability of occurrence with significant impact) that may prevent the company from achieving its objectives.
Identified the significant business risks the company management should define the possible responses. The answers can be:
- Accept the risk (assume the impact)
- Attempting to reduce risk (implements controls)
- Transfer risk (use insurance)
- Avoid risk (withdraws from the environment that generates the risk)
Auditors should also support the task of the company’s management in identifying significant business risks and evaluating the actions taken by the organization to mitigate them as a way to create and protect value for its customers. The above, taking into account that the significant business risks that materialize can significantly affect the company’s financial statements and in some cases the auditor’s opinion. Example: business problems in progress.
Here are 7 business risks that every auditor should consider:
- Entry of new competitors
The entry of new competitors leads to a decrease in sales and an increase in returns on sales and consequently an obsolete, damaged or slow-moving inventory.
Some ways in which this risk can materialize are:
Free trade agreements
These treaties can facilitate the entry of new competitors entering the market offering quality and low prices
Import of Chinese products
Chinese products are characterized by being inexpensive products and that when entering to compete with products manufactured in the country can be attractive for the customers.
Own brands
According to Wikipedia, it is the brand belonging to a chain of distribution (usually hyper or supermarket) with which products from different manufacturers are sold
Some advantages of own brands:
Usually, they are brands cheaper than the marks that distribute the manufacturer when saving costs in advertising and promotion
In many cases, the product is identical to that marketed by leading brands but at a lower cost
The manufacturer is guaranteed the implementation of its product in a concrete and wide market, the distributor’s points of sale.
Smuggling
It is the purchase or sale of goods evading tariffs, ie evading taxes, which means that when entering to compete with legal products their selling price is much lower, affecting in a significant way legal companies.
Product Counterfeiting
In the market, there is a large number of counterfeit products, which use well-known brands but with false content and which is usually sold at a lower price.
- Substitute products
Substitute products can perform the same functions of the product offered by the company covering the same needs at a lower price, with superior performance and quality. The entry of substitute products leads to a decrease in sales and an increase in returns on sales and consequently obsolete, damaged or slow-moving inventory. Examples:
Tea is a substitute for soft drinks
Mobile telephony is a substitute for fixed telephony
Taxi applications are a substitute for radio taxi companies
The sale of music on the internet is a substitute for music stores
- Dependence of income on few clients
Revenue dependence on few clients is one of the most common business risks in organizations and occurs when a significant portion of revenue is concentrated in few clients. Example: More than 30% of revenue is concentrated on a customer. This risk can be materialized as follows:
Loss of the customer
The problem of relying on one or a few clients is that when our client chooses to change us for another, it can surely jeopardize the survival of our business, taking into account that there are fixed costs and expenses within the organization that can lead to significant losses within of the company for the lower revenues to be received.
Customer financial problems
Another important point is that normally those clients within the organization’s portfolio represent important amounts that at the time of suffering some type of economic difficulty, for example bankruptcy, can generate a difficult recovery portfolio that must be provisioned by our organization, reducing significantly the liquidity of the company and generating significant losses for the Company.
- Absence of an effective Internal Control system in the organization
The absence of effective internal control in the organization can generate a high degree of vulnerability to the materialization of business, fraud and process risks. Example of materialization of these risks
A company that does not permanently monitor its external environment can be impacted by important political, economic, social, technological or environmental phenomena
A company that does not monitor the environment of its industry can be significantly impacted by competitive phenomena (new competitors, substitute products, product innovation, among others)
A company with an inadequate segregation of functions within its processes may create opportunities for fraud
A company where controls do not respond to the materialization of risks can generate significant losses
Ineffective internal communication can cause the company to fail to meet its objectives
- Environment
For organizations where the development of their social object depends directly on renewable natural resources, the current climate changes (drought, winter or frost) can generate shortages of products due to crop losses.
For organizations where the development of their social object depends directly on non-renewable natural resources, their exhaustion may jeopardize the continuity of these businesses taking into account that there is normally total dependence.
Example of materialization of these risks:
For food producing companies, times of drought or winter generate increases in the costs of their products due to the lack of food. This can generate sales at a loss.
For companies that grow flowers, frosts can significantly affect their crops, causing significant losses to the business to the point of jeopardizing their continuity.
For companies that exploit non-renewable resources such as oil and mining, depletion of these may jeopardize their continuity.
Climate change can affect consumer buying habits by generating high levels of obsolete, damaged, or slow-moving inventory. Example: The clothing of the inhabitants of a region can change due to global warming.
Natural disasters in the place where the company has its facilities
- Risk-generating strategies
Strategies are set by organizations to achieve their goals, but in some cases, these strategies can generate business risks.
An example of the materialization of business risks generated by the implementation of strategies:
The company’s processes do not support the stated objectives and strategies. Example: Among the objectives of the company is a growth in sales of more than 30%, for which the company has defined an increase in advertising expenses, without taking into account the capacity of the production processes. That is, I can attract customers but I do not count on the infrastructure to respond to those new clients which can generate the loss of image.
Diversification of products: Diversification can generate cannibalization which means that new products can affect sales of current products
Integration Strategies: A company that acquires another company to achieve a majority stake in the market may be investing in a company with ongoing business problems and/or financial problems that may affect it in the future.
- Power of negotiation of the clients
When our organization depends on a few customers or large clients, they can impose their conditions (sales price, discounts, sales returns, services, payment method, product quality, etc.), generating high costs for our organization and, consequently The sale of products at a loss. Example:
Large supermarket chains usually impose their conditions on their suppliers and in some cases sales to these types of customers end up being at a loss and/or a low profitability for our organization.