We need to assess all possible risks that may have a negative impact to project before its implementation. Underestimating of certain risks could cause loss of profits or even complete failure of the project. We will talk how to define economic risks in this post.
We have already said that there are several basic types of project risks: political, economic, legal, technical, environmental and other risks in the article about the classification and assessment of project risks.
Economic risk definition.
Economic risk is the risk that is associated with the influence of financial and other economic factors on the project.
Assessment of economic risks is crucial in assessing the overall risk of the project. Economic risks have a direct impact on the revenues and expenses amount and accordingly the company’s profits.
The main types of economic risks are the following:
- Risk of rising prices for raw materials and energy. Increasing prices for material resources increases the cost of manufactured products. If company operates in a competitive market and product prices can not be raised rising of costs leads to a decrease in profitability.
- Risk of minimum wages increasing. Labor costs increasing also increases production costs. The government may increase the mandatory minimum of workers wages, and this can lead to an increase in the size of all wages in the economy.
- Risk of production prices reduction. Decrease in market prices for the company production also leads to a decrease in profitability, even if the costs remain stable.
- Interest rate risk (credit risk). If company uses credit resources to project, the rising of interest rates on loans can have a significant negative impact on financial performance.
- Risk of higher taxes and duties rates. This risk can be called economic-legal risk. The growth of existing taxes rates or introducing of new taxes leads to a decrease in profits. The risks of new duties on exports and imports introducing can also be attributed to this category of economic risks. New export or import duties may even lead to the companies which conduct export or import activity termination.
Besides the above there are other economic risks, such as foreign currency exchange risk, which is also very important in the import-export business or upon receipt of foreign currency loans.
To assess the economic risks in order to its minimization managers need to learn all the available information.
A characteristic feature of economic risks is that they can be estimated with a fairly high level of reliability.
The initiators of the project should create some reserves to cover the possible negative consequences of the economic risks onset.
For example, a manager should look for alternative suppliers to minimize risk of material resources price increase.
Manager should explore opportunities of refinancing to minimize risk of interest rates rising.
There should be a special system of continuous economic risk monitoring and control in a company which would allow responsive to occurrence of certain risks and take measures to avoid them.