Types of Risk

Topics: Risk, Finance, Generally Accepted Accounting Principles Pages: 5 (1524 words) Published: May 19, 2013
Additional useful information on types of risk

Market or price risk relates to the uncertainty in markets and prices for both inputs (purchased for the production process), and outputs (products and services for sale by the firm). Market/price risk has always been a major problem in most businesses and results from the economic forces of supply and demand. Outcome of these forces are fluctuations in the price for a commodity and/or inputs in the production of that commodity. These fluctuations may be short-term and long-term. The degree of fluctuation and the length of time are critical to their effects on the business. Managers generally anticipate some degree of fluctuation in prices and plan accordingly. These plans may include spreading production and sales over time to average the effect of peaks and troughs in the market, establishing contracts to obtain a fixed price, and 'pooling' sales with other producers to obtain a better market or an 'averaging of returns' from the larger organisation. Low prices in the short term may be tolerated by a business if it has sufficient cash reserves to meet negative financial returns from lower prices. Low commodity prices in the longer term pose serious threats to the viability of the enterprise, and the business, should that enterprise form a major source of income. The growing impact of globalisation and opening of most world economics is also increasing the variability of market and price risk. Remember that this includes both opportunity and potential loss. Production risk is the variability inherent in the firm's production processes. This is predominantly the variability of product yield, both in yield quantity and quality. Often quantity is considered but quality is also an important consideration – particularly for products where warranty and service support are provided. Variances in labour, weather, transport and inventory can all reduce (or increase) expected output, or cause delay in the production cycle of any business. Quality reduction, or delay in the production cycle, can further reduce the expected market or price returns for the unit of production. A delay in the production cycle can result in an inferior product or additional time and costs to finish the product, thus reducing the margin of returns from the enterprise. Technological risks: these relate to the uncertainty caused by rapid technological change. A production or investment decision made today may be affected by technical improvements in the future. This is particularly important for structures and high cost, long-life plant. A change in technology may place the business in a less efficient and less competitive situation against its competitors and the marketplace. Similarly not keeping up with technology can also make the business less efficient and less competitive. A business not utilising EFTPOS would find business quite difficult. Some investments can take upward of ten years for the planned commodity to settle into full production (e.g. horticultural products such as fruit or nuts. Agro forestry is a particularly long-term investment, as is mining). Human risks: humans are a key source of risk. Humans are prone to mistakes, misinterpretation, and health problems. The goals and objectives of management form the long- and short-term business plans for the firm. The fact that humans tend to change their goals and objectives often adds to the uncertainties facing the firm. Humans have skills limitations. The introduction of a new process or new technology may require new and sophisticated skills. Humans interpret, learn and respond to situations in different ways. Examples of human risk situations include:

health and injury problems, particularly with key personnel. mistakes made in the production process.
breakdown in interpersonal relationships within the workforce. misinterpretation in communication.
resistance to change.
An inability to learn.
the existence of vices such as greed and...
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