Commercial risk

Commercial risk
Primary topic
Related topics
Methods and techniques

The term of commercial risk determines the basic risk which is covered by trade credit insurance. Commercial risk is associated with the risk of trade partner and his financial standing, payment habits and his honesty in meeting obligations arising from the sale agreement.

Commercial risk consists of two basic issues:

  • insolvency legally confirmed (insolvency or threat of insolvency in accordance with the law of bankruptcy or restructuring law),
  • a significant delay in payment (a situation in which the recipient did not pay for the delivered goods or the provided service, and the delay has a certain number of days).

Nowadays, over 80 % of global trade is carried out with a deferred payment date. The length of the trade credit period depends on the type of commodity. For consumer goods it is the shortest (about 30 days), on the opposite side are investment goods, where the payment term grows from one year upwards. Due to the growing competition of the company, who are contend for the client, the payment term will be longer[1].

Leverage and Commercial Risks[edit]

Commercial risk of the undertaking in large measure factor into corporate profitability. Profits will be liable to higher uncertainty and hesitation whereas high commercial risk occurs. High financial leverage level put the company’s stockholders out to the risk of variable profit. The commercial risk exists during occurring feature exposure to:

  • market-based business cycles,
  • risks from competition,
  • the risk of legislation or government intervention affecting the company's business,
  • the risk of product senescence and technological change ( a quick pace of technological difference in the business),
  • price sensitivity of the retail (differences in prices in the business’s products).

Companies which are marked by high operating leverage can be incurred by particularly high commercial risk. The formula of the way that income changes with a decrease or increase in sales refer to the cost arrangement of a business's operations named operational leverage[2].

Low Operational Leverage[edit]

Low operating leverage occurs during variable costs are approximately high just as a proportion of sales but fixed costs are fairly low. In the result[3]:

  • the net income of profit margin is relatively low as well as the change in complete income for each 1 dollar decrease or increase in sales in fairly low,
  • during a fairly low amount of sales fixed costs are covered ( a breakeven level is at a fairly low amount of sales),
  • operating income is fairly stable in spite of changes in turnover from one year to the next one.

High Operational Leverage[edit]

High operating leverage arises during relatively high fixed costs of the company and relatively low variable costs. The change in profit for each 1 dollar decrease or increase in sales in high. In the result[4]:

  • a high volume of sales require just to cover fixed costs and breakeven level,
  • profits change strongly when sales fall or rise, and has a tends to fluctuate strongly in the business cycle of recession and growth.

Footnotes[edit]

  1. (T. Nektarios 2015)
  2. (A. Graham 2004, p.31)
  3. (C. Gardner 2010)
  4. (A. Graham 2004, p.32)

References[edit]

Author: Alicja Ryszka