Meaning and Types of commercial risks. in English

Contents

What are commercial risks. Explain in detail?

Commercial Risk can be defined as Financial Risk taken by a seller while extending credit without securing any collateral or recourse. It generally includes all risks other than the Political Risk.

It refers to probable losses arising from the business partners or from the market. In order to reduce Commercial Risk, It is very important to ensure that the trading partners are reliable. It is also important to take into consideration the trading partner’s possible insolvency or indisposition to payback. The method of payment is of high importance.

For example – whenever a tailored product is manufactured, it is recommended you an advance payment or documentary credit is chosen as the method of payment. Various situations can be observed where commercial risk becomes a reality –

The trading partner is unable to deliver or pay for the services/ products as agreed.
The trading partner is not willing to act as per the conditions stated in the agreement.
There are differences in the interpretation of the trade agreement.

The term commercial risk means there’s a potential for loss with a trading partner. What kind of loss? Basically it can happen one of three ways:

1. Your customer can’t pay for the products or services you provided according to the terms of your agreement.

2. Your trading partner doesn’t live up to their obligations within the agreement (i.e. not meeting delivery dates).

3. You and your trading partner may have differences in interpreting the agreement.

If you and your trading partner are in different countries, the degree of difficulty is magnified. Think about dealing with different laws, languages, cultures, currencies, and customs policies, and you can see where the complexity comes in. Let’s look at some areas of concern.

There are several ways of identification of Commercial Risk-

1. Worst Case Scenario: It represents the most disastrous possible outcome. In simple transactions it can be only a sum of money which is lost whereas in big critical business deals it can encompass money, image, trust, brand equity and a lot more.

2. Volatility : It is the measurement of stability of any variable over time. The most common usage of volatility in commercial risk assessment is in case of stocks. The volatility of stock markets gives a measure of the risk involved in it.

3. Value at Risk: Value at risk also known as VAR is a mathematical model used by analyst to assign probabilistic values to possible losses. It is closely related to volatility method. It can be used to assign probabilities to a range of losses as well. It gives us a prediction of the transaction as per the model.

4. Historical Averages: It is a very generic approach where you identify similar transactions done by you, your partner or anyone in the market. One tries to find resemblance in the conditions and takes out an average of outcome of identified transactions to get an idea of risk involved.

Different Types of Commercial Risks

1. Country Risk: Let’s say your trading partner is located in a country where there is political unrest or labor strikes. Or maybe your country is in a trade war with another country and imposes tariffs (a tax levied against imports to help domestic producers) or quotas (quantity restrictions) on products you’re importing. There are also country-specific administrative procedures, bureaucratic procedures, regulations, and technical standards. Does all this change the equation? Absolutely it does.

2. Currency Risk: The value of currencies and exchange rates (value of a currency for conversion purposes) frequently fluctuate, which makes international deals complicated. Variations in the exchange rate can affect the payments that trading partners owe each other, and large swings in currencies can affect the actual values of companies. One country could be suffering from inflation while the trading partner’s country is not. This can make returns on investment uncertain, and businesses typically don’t like uncertainty.

3. Cross-Cultural Risk- Cultural misunderstandings or language barriers can contribute to business snafus. For example, some areas like South America require more detailed explanations of agreements (we’ll call that high context) than their counterparts in the US or Canada (we’ll call that low context). Even simple words like “yes” can take on different connotations; in some parts of the world it signifies agreement, in other parts it simply means you were understood but not necessarily in agreement. Business practices and making relationships are also handled differently.

4. Strategic Risk: Suppose you chose poorly when you picked an international trading partner due to lack of local knowledge, or that you miscalculated shipping times due to inexperience. Also, your product might not be suitable in another market. For example, not all smartphones work in international markets; different chip sets might be required. People in one country may not be willing or able to pay an equivalent amount for a product as the consumers in another country. Strategic risks are usually associated with a lack of knowledge about the foreign country or trading partner.

5. Minimizing Risks: Commercial risks can eliminated entirely, but they can be mitigated to a certain extent. The never be safest play is to do business domestically but that’s also where you probably face the greatest competition. Doing business internationally may be worth a calculated risk.

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