Insurance covers various risks of traders and others. Therefore the concept of risk need to be studied. The term ‘business risk’ refers to the possibility of inadequate profits or even losses due to uncertainties or unexpected events. Risk is different from uncertainties.
Business risks can be understood in terms of their peculiar characteristics:
Uncertainty refers to the lack of knowledge about what is going to happen in the future. Natural calamities, change in demand and prices, changes in government policy, improvement in technology, are some of the examples of uncertainty which create risks for business because the outcome of these future events is not known in advance.
Every business has some risk. No business can avoid risk, although the amount of risk may vary from business to business. Risk can be minimized, but cannot be eliminated.
Nature of business (i.e. type of goods and services produced and sold) and size of business (i.e., volume of production and sale) are the main factors which determine the amount of risk in a business. For example, a business dealing in fashionable items has a high degree of risk. Similarly, a large-scale business generally has a higher risk than what a small scale business has.
‘No risk, no gain’ is an age-old principle which applies to all types of business. Greater the risk involved in a business, higher is the chance of profit. An entrepreneur undertakes risks under the expectation of higher profit. Profit is thus the reward for risk taking.
The business risks may be classified as
Speculative risks are the kind of risks which have the possibility of gain as well as the possibility of loss. Such risks are the result of market conditions. Favourable market conditions result in gains whereas unfavourable market conditions result in losses.
Example: Use of better technology helps to produce better quality products at cheaper prices. This may increase the demand and thus result in higher profits.
Pure risks are the type of risks where business suffers loss only if the risk occurs. Non- occurrence of such risks leads to absence of loss.
Example: Business may suffer loss only if fire, theft or strike occurs.
Insurable risks are the type of risks where business can insure the probable losses by paying a predetermined premium to an insurance company. At the time of loss the insurance company pays compensation on the basis of agreed terms and conditions. Loss arising from natural and physical risks can be insured as the probability of risk can be determined.
Example: Company can insure its stock against fire or theft and if it loses its stock due to fire or theft in office, the insurance company pays compensation only upto a extent of the value lost.
Losses arising from unforeseen natural events, political changes or trade cycles are called uninsurable risks. Loss due to earthquake or flood or cyclone cannot be estimated and their probability cannot be calculated. Government directly takes care of the affected persons. Losses to businesses due to policy decisions of ruling political parties in a country, or due to economic depression cannot be insured. These uninsurable risk events are called uncertainties. The concept of risk is different from uncertainty. During uncertain events decisions cannot be taken.
Business risks arise due to a variety of causes, which are classified as follows:
Human beings have little control over natural calamities like flood, earthquake, lightning, heavy rains, famine, etc. These result in heavy loss of life, property, and income in business.
Human causes include such unexpected events like dishonesty, carelessness or negligence of employees, stoppage of work due to power failure, strikes, riots, management inefficiency, etc.
These include uncertainties relating to demand for goods, competition, price, collection of dues from customers, change of technology or method ofproduction, etc. Financial problems like rise in interest rate for borrowing, levy of higher taxes, etc., also come under this type of causes as they result in higher unexpected cost of operation of business.
These are unforeseen events like political disturbances, mechanical failures such as the bursting of boiler, fluctuations in exchange rates, etc. which lead to the possibility of business risks.