Risk in an entrepreneurial activity

Risk in an entrepreneurial activity

THE MINISTRY OF EDUCATION AND SCIENCES OF THE RKINTERNATIONAL ACADEMY OF BUSINESS

“ECONOMICS AND LOGISTICS” DEPARTMENT

THE TERM PAPERTHEORY

“Risk in an entrepreneurial activity”

by the 1st year student“Finance” specializationL.T.bysenior lecturerA.K.

Almaty 2011

Content

Introduction

Chapter 1. Theoretical bases <#"663932.files/image001.gif">

Graph 1. Dependence of profit on risk evaluation

follows from graph 1 that zero risk provides the lowest income (0; P1), and at the highest risk R = R2 the profit has the highest value P= P3 (P3> P2> P1). It is impossible to eliminate uncertainty of the future of an entrepreneurial activity, as it is an element of the objective reality. The risk is inherent in business and is an integral part of its economic life. The principle decision on accepting of the risk project depends on businessman, making the decision, on its preferences between expected return (profitability) of means put in this project and their reliability which in turn is understood as non-risk, probability of reception of incomes. This map assumes also accounting of several utility levels for the businessman. In figure is shown the general view of the similar map of preferences.

of risk preference.have a positive slope on the map of risk preference. The curves represented in figure called “curve of equal preferences” or “curves with indifference”. Each of them shows the points of equal - prefer pair of efficiency expectation and risk of the decision for the businessman at the given level of its satisfaction. Acceptable levels of satisfaction (utility) may be several. In this figure there are three, the lowest of all acceptable is level F1, the most high is F3. F1 level is lower than the F2, so in the first case (for F1) the amount of risk R3 is greater than the risk of R1 at the same expected profitability solutions. Map of risk preference should be built by entrepreneur or by outside experts. It should be based on data analysis of decisions taken earlier.consequence of risk shown up most often in the form of financial losses or the inability to obtain expected profits, the risk is not only undesirable results. In certain versions of business projects exists not only danger of not achieving the intended result, but also the probability to exceed the expected profit. This is the entrepreneurial risk, which is characterized by a combination of the possibility of achievement as unwanted results and favourable deflection from planed results.

1.2 The concept of risk

business economic risk

First of all, it is necessary to determine the original, basic concept of "risk" and its classification for further consideration of the entrepreneurial risk. The notion of risk is used in a wide range of sciences. Law sees risk in connection with its legality. Catastrophe theory applies the term to describe accidents and natural disasters. Research of risk analysis can be found in the literature on psychology, medicine, philosophy; each examination of risk is based on the subject of study of the science and, of course, relies on its own approaches and methods. This diversity of risk studies is explained by many aspects of this phenomenon.the domestic, economic science is not essentially generally accepted theoretical principles of entrepreneurial risk, not actually developed risk assessment methods as applied to various industrial situations and types of business, there are no recommendations on ways and means of reducing and preventing risk. Although it should be noted that in recent years scientific work appeared, in which are the issues of planning, economic activity of commercial organizations, the relationship between demand and supply issues, such as: "risks in modern business" (authors); Rajzberg’s B.G. monograph, "ABC Enterprise" monograph of Pervozvansk A.A. and Pervozvansk T.N. called "financial market: calculation and risk", etc.specific interest is comparative consideration of classical and neoclassical theory of entrepreneurial risk and economic appendix. In the study of business profit, such representatives of classical theory J. Mill, I.U. Senior recognized the percentage of entrepreneurial revenue (as share in capital), wages of businessman and a pay for risk (as compensation for the possible risk associated with business activities).the classical theory of entrepreneurial risk the last is identified with the mathematical expectation of losses that may occur as a result of the selected solution. In this theory the risk is explained as the damage caused by the implementation of this decision. In the 30 years of our century economists A. Marshall and A. Pigo developed framework of neoclassical theories for business risk. The foundations of this theory are: entrepreneur is working in conditions of uncertainty and profit which is a casual variable, the transaction is governed by two criteria:

• The size of the expected profit;

• The size of its possible fluctuations.'s behavior, according to neoclassical theory made from the concept of marginal utility. This means that if you have two variants, for example, capital investments with the same expected profit then employer elects variant with fewer fluctuations in the expected profit. If you accept a small number of decisions of the same type, you cannot expect that deviations equalize mutually from the expected profit. That is why an entrepreneur, which is making a decision, should take into account fluctuations of income and choose the variant that gives the same result and characterized by fewer variations. According to neoclassical theory, for entrepreneur less interesting the profits associated with possible variations.works of the Hungarian economists T. Bachkai, D. Mossen and others continued further development of the neoclassical theory of risk. They see the essence of risk in the possibility of deviation from aims for achievement of it was made decision.problem of risk “has matured” enough in our country. However, now, as noted by A. Algin, a list of literature about the risk unfortunately poor, fundamental research, essentially, absent. The case is limited to a few journals and newspaper articles mostly the essay nature. The problem has not received proper explanation and practice managers.. Abchuk and a. Algin defines risk as the activity or action on “the removal of uncertainty”. L. Rastrigin and B. Rajzberg define risk as "damage, possible losses, according to the classical theory of entrepreneurial risk. Analysis of the many definitions of risk allows identifying the main points that are specific to risky situations, such as:

• Accidental character of events that determines which of the possible outcomes is realized in practice;

• The availability of alternative solutions;

• Is it known or it is possible to determine the probability of outcomes and expected results;

• The possibility to obtain an additional profit., the category of "risk" can be defined as the risk potential danger, the probable loss of resources or deficiency of revenue compared to their expected value-oriented management of resources in the enterprise activity. In other words, the risk is the threat that the employer has incurred losses in the form of additional spending or receives revenues below those at which he had expected. Under the business understood risks arising in all types of business activities related to the production of goods and services; inventory money and financial operations; commerce, as well as the implementation of scientific-technical projects.

.3 The classification of business risk

complexity of the classification of business risk is their diversity. In addition, economic and political development poses new risks in the modern world that are difficult to determine and asses quantitatively. In the economic literature on entrepreneurship, there is no system of classification of the business risk. First of all it must select the types of risks, grouping them according to certain characteristics. Based on the sources of risk should be distinguished:

the risk associated with business activities;

the risk associated with individual entrepreneur;

the risk associated with a s shortage of information on the status of the external environment.origins of business risks can be divided into external and internal. The source of external risks is the external environment in relation to the business firm. The entrepreneur cannot influence on them, he can only anticipate and take them into his activities. It is about the unforeseen changes in legislation; the volatility of the political regime in the country. Internal risks arise in the case of ineffective management, mistaken marketing policy, and as a result of internal abuse. It is the human risks associated with the professional staff of entrepreneurial firms.the level of decision-making single out: macroeconomic (global) risk and risk at the level of individual firms (local). In terms of duration in time business risks can be divided into short-term and constant. The short-term include the risks that threaten the entrepreneur in the course of known duration. For example, the transport risk is when losses occur during the carriage of goods or the risk of non-payment on a specific transaction. The constant risks include risks that right along threaten business activities in a given geographical area or in a particular economic sector, for example, the risk of non-payment in the country with the imperfect legal system or risk of the destruction of buildings in the area of seismic risk.should be also provided an admissible, critical and catastrophic risk . Admissible risk is a threat of "total loss of profit from realization of a project or business as a whole. In this case losses are possible, but their size is less than the expected business profits.risk associated with risk of losses in the amount of costs incurred for the implementation of the business activity or transaction. The first degree critical risk is the threat of getting zero income, but claims compensation of entrepreneur material costs. The second degree critical risk is the possibility of losses in the amount of total cost of the business.risk is characterized by the threat of losses in an amount equal to or greater than all the property state of the entrepreneur. Catastrophic risk usually leads to bankruptcy business firms.the level of legality single out: justified (lawful) and unjustified (unlawful) risks. To differentiation between justified and unjustified entrepreneurial risk, in the first place should consider the fact that the boundary between different types of business in different sectors of the economy is different.business risks can also divide into two major groups according with insurance: insured and non-insured. Risk insurance is a probable event or set of events, in case of which carry out insurance. Depending on the source of the risk of insurance risks are divided into two groups:

risks connected with the manifestation of elemental forces (weather conditions, earthquakes, floods, etc.);

risks connected with purposeful human actions.if the losses as a result of the insured risk is covered by insurance companies, a losses as a result of the non-insure risk is reimbursed from the own means of entrepreneurial firms.should be selected two other large groups of risks: statistical (simple) and dynamic (speculative). Peculiarity of statistical risk is that they always carry the losses of business. The loss for entrepreneurial firms tends to mean losses for society as a whole.compliance with the cause of the loss of statistical risks, they can be divided into the following groups:

• expected losses as a result of negative actions of natural disasters (fire, water, earthquakes, hurricanes, etc.) on the assets of the firm;

• expected losses due to criminal acts;

• expected losses due to an adverse legislation for entrepreneurial companies (losses related with direct seizure of property or with the inability to recover compensation from the perpetrator caused by imperfection of the legislation);

• expected losses caused by third persons threat of property, which leads to the forced stop actions of the main producer or consumer;

• losses as a result of death, or disability of key employees, or a main owner of the business firms (because of the difficulty of the placement of personnel, as well as problems with the transfer of ownership).the statistical risk, the dynamic risk carries either a loss or profit for entrepreneurial firms. Therefore, they can be described as "speculative".are also existed risks, classification of which is based on the separation of risks on the nature of the activities with which they are associated. They are: political risk, production risk, commercial risk, financial risk, technical risk, branch-wise risks and innovation risk.

.4 Types of losses

To assess the probability <#"663932.files/image002.gif">

risk assessment consists in the analysis sensitivity of financial results to changes in basic parameters of activity in conditions of uncertainty variability of the market situation, as efficiency of management decisions are always linked to the risk of deviations of actual data from the planed data. This is a qualitative approach to measuring risk.of unsystematic risk of the enterprises is carried out in the following areas:

·        nature of business;

·        external environment;

·        quality control;

·        the nature of the activities;

·        financial condition.practice for risk assessment most frequently used expert (qualitative) methods based on subjective evaluation of expected performance. For example, the financial condition of enterprise experts can evaluate by dividing into high, medium, and low risk in terms of the following.) Using of credit:

·        the risk level is high, if the company cannot undertake current activities without the using of borrowed funds;

·        the average level of risk, if the business requires investment credits for development, business expansion;

·        the low level of risk, when the company did not resort to credit or use them occasionally.) The level of own working capital:

·        high risk, if there are problems (shortage of) their own working capital;

·        the average risk- working capital financed by equity to total assets ratio <#"663932.files/image003.gif">

Appendix 3

of market attractiveness and strategic situation of business