Business risk and its relevance

Boring definition : 

According to ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment “A business risk is one resulting from significant events, conditions, circumstances, actions or in-actions that could adversely affect an entity’s ability to achieve its objectives and execute its strategies”.
 
 

Interesting definition: 

Any future event that might prevent the company in making money & challenges its going concern.
 

Significance of Business Risk in Audit Process:

In real life audit process has changed drastically due to severe competition, tendering process as well as pressure of reducing audit fees. Hence audit process has to be efficient, quick and effective since firms cannot afford to spend huge amount of time or provide large audit team for any assignment.
Consequently ‘Top-down Approach’ has been introduced in audit practice where the main idea is to look for the future risks; the business is going to face to its continuing operations. Therefore in modern audit process an auditor would identify those ‘risky areas’ which might prevent the company in making profit, before conducting any other detail audit procedures. The auditor than would focus mainly on those risky areas and adopt procedure to detect material misstatement in those areas alone.
So business risk identification makes the audit process easy, efficient, less time consuming and precise. Looking at business risk makes auditor aware about the strength of company’s internal control as well as corporate governance policies and procedures. Any weakness or non-compliance might indicate areas auditor should concentrate in finding misstatement. That is why ‘top-down approach’ is so popular among auditors now-a-days and that makes it very very important for the exam. 
 

Classification:

risk classification.png
Internal Risks (CFO):These risks are entirely related to company’s internal business process.
 
Compliance (C) – fraud, not complying with local GAAP, rules and regulations, stock exchange or corporate governance best practice 
Financial (F) – cash flow difficulties, rapidly increasing gearing 
Operational (O) – employees going for strike, failure to modernize products,    processes, labor relations or marketing; excessive reliance on dominant CEO 
External Risks (PESTEL):These are mainly related to the industry company is operating.
 
Political (P) – political issues 
Economic (E) – changing interest rates, exchange rates 
Social (S) – change in public opinion, attitudes, fashions 
Technological (T) – untried technologies and ideas 
Environmental (E) – natural hazards 
Legal (L) – changing legislation 
Common Business Risks for Exam:
 
Circumstances
Business Risks
Wide geological operation
Control + Regulation + Tax
E-commerce
Volume of transaction + Security + Data protection
Outsourcing
Quality
Financial performance
Revenue + Liquidity + Gearing + Margin
Litigation
Reputation
 
One piece of advice, please do not try to memorize examples of business risk because the case study of the question will be ‘freshly made’ for you. Just remember three words: Future, Money & Going concern. Practice some past exam questions in time pressure. Your nightmare regarding business risk will be over.