Business risk is an event, circumstance or condition that may result in an organization failing to achieve its objectives or adversely affect its strategy. For example, a risk that a company might fail to improve sales, reduce costs or successfully launch a new product under development.
Most business risks impact a company’s financial statements. If a company doesn’t correctly record the financial impact of a business risk, its financial statements will be materially misstated. Therefore, business risks are assessed by auditors as part of risk assessment activities and to design audit procedures to detect the possible misstatements in the financial statements.
The following is a list of business risk examples, though not comprehensive, typically faced by companies. Each example also explains how the business risk may lead to risk of material misstatement of the financial statements.
Businesses are exposed to the risk of being left behind in the race for constantly improving technology. Their methods, techniques and products will become outdated thus resulting in lost sales or inefficient production. A new method of production may lead to superior quality products resulting in impairment of inventory already held by a business. The corresponding risk of material misstatement is that inventory is overstated in balance sheet and cost of sales understated in income statement.
Laws and Regulations
Laws and regulations are almost entirely out of a company’s control. Due to changing legislation and volatile political environment, businesses are constantly at risk of higher taxes, ever stringent regulations and risk of inadvertently breaching laws. These may lead to a range of material misstatements in the financial statements. For example, those related to taxation, legal obligations and provisions etc.
A company may find itself in shortage of cash. The management of the company may find themselves compelled to show a better picture of the business in the financial statements in order to secure additional financing. There will be a risk of management bias in estimates and accounting policies.
Fierce competition may result in a company finding it difficult to stay in business. If the company’s financial statements are prepared on going concern basis, there is a risk that the company might not actually be a going concern and therefore the financial statements will be materially misstated.
Businesses are at risk of fraud being committed by management, employees or those outside the organization. Fraud will most likely result in financial impact and therefore may result in a risk of material misstatement in the financial statements.
by Irfanullah Jan, ACCA and last modified on