Business Risk | Factors Affecting Business Risk of a Firm | Financial Management | Management Notes
Business Risk Definition
The business risk of a firm is measured by the variability in the operating income of the firm. Larger variability in operating income denotes larger business risk. The firm’s business risk changes over time and it varies from firm to firm. Some factors affecting the business risk of a firm are as follows:
The operating income of the firm fluctuates widely if variability in demand for a firm’s product is larger. Thus, a firm with larger variability in demand is more exposed to business risk.
Variability In Selling Price
A firm’s product does not sell at constant price. The selling price of the firm’s product may be volatile because of alternative demand and supply conditions, nature of competitions and so on. Thus, larger the variability in selling price wider will be the fluctuations in operating income leading to higher business risk.
Uncertainty Of Input Costs
The cost of input keeps on changing over time, affecting the total cost of output. The total operating cost of the firm widely fluctuates if the uncertainty associated to input cost is larger. This exposes the firm to high business risk.
Ability To Price Adjustment
When there is an increase in input costs, the selling price must also increase to maintain stability in the firm’s operating income. However, the speed with which selling price is adjusted in response to the change in input costs depends on the price adjustment capacity of the firm. Thus, higher the firm’s ability to price adjustment, lower will be the business risk.
Speed Of Technological Changes
The firm should adapt to changing technology over the years. If the speed of technological changes is greater and the firm is not able to adapt to changing technology, demand for firm’s product will be adversely affected. The level of business risk associated to such firm is larger.
Extent Of Fixed Operating Costs
If larger portion of the firm’s costs are fixed, the firm has to make larger sales to meet the fixed costs. At lower sales level such firm is not able to meet the fixed cost. There larger fixed cost exposes the firm to larger degree of business risk.