Risk and Reward

Risk is the possibility that a business decision may lead to loss, harm or an unwanted outcome. Every choice an entrepreneur makes carries some: launching a new product, borrowing money for equipment or renting a second shop could all go wrong. No owner can remove risk completely, because nobody knows for certain how customers, rivals or costs will behave.

A calculated risk is not the same as a reckless gamble. It is taken after the possible advantages have been weighed against the possible disadvantages, instead of acting on a hunch. Imagine you run a bike repair workshop and the unit next door becomes empty. The extra rent, insurance and a second mechanic's wages are the disadvantages; the extra repairs you could complete each week are the advantage. Putting rough figures on both sides tells you whether the move is sensible.

Judging whether a risk is worth taking

Successful entrepreneurs do not try to avoid all risk, because a business that never takes a chance rarely grows. Instead they look for the opportunity inside a risky situation and judge whether it is worth taking: would the benefit you hope to gain be big enough to justify the loss you might suffer? A cautious owner might test a small market first, ask potential customers what they would actually buy, or gather quotes for costs before signing anything. Each of these reduces the unknowns, so the decision rests on evidence rather than hope.

Business failure is the risk that a business does not survive or has to stop trading. When a business closes, its owners lose the income and money they put in, and staff lose their jobs. Failure can hit a brand-new venture with little cash and few customers, but it can also hit a business that has traded for decades.

One clear cause of failure is not having enough finance to meet its debts. Bills for rent, stock and loan repayments fall due whether or not sales have been strong, so a business can run out of cash and be forced to close even when its product is good. Failure is not the same as financial loss: a business that keeps trading can still lose money, but a failed business has stopped trading altogether.

Why businesses fail

• Insufficient demand — too few customers want the product, so revenue never covers costs. A new skateboard shop in a small town may find only a handful of buyers each week.
• Poor cash-flow management — money leaves the business before payments from customers arrive, leaving it unable to pay wages or suppliers.
• Failure to respond to changing market conditions — customers move on and the business does not. A high-street photography shop that ignored phone cameras and online printing lost the customers it once relied on.
• External factors beyond the business's control — a recession, a change in the law or a sudden rise in costs can reduce sales or raise expenses whatever the owner does.

External factors and the risk–reward balance

Factors outside the owner's control raise the risk — the chance of loss — and so reduce the chance that the reward will be achieved. If a recession cuts household spending, a garden centre's sales may fall just as its loan repayments stay the same. Because the owner cannot control these events, the possibility of failure grows, which is why some people decide the potential profit is not worth the risk.

Financial loss is the risk that money put into a business, or money needed to keep it running, is lost. Any business decision involving money can carry this risk.

Starting or running a business usually needs financial investment: money put into the business, for example for equipment, stock, premises, marketing or staff. If the business does not survive, the owner may not get that money back. Financial loss is not the same as business failure: failure is the business not surviving, while financial loss is money lost. Owners can lose money too, not only investors, because they may put their own savings into the business.

How financial loss can happen

Even a business that keeps trading can lose money. Three common causes are:

• Lower-than-expected sales: revenue is less than planned, so money spent on stock or promotion may not be recovered.
• Higher-than-expected costs: materials, energy or wages rise, leaving less money over.
• Unexpected expenses: a broken freezer, an urgent repair or a legal bill has to be paid.

For example, you open a small plant shop and spend £3,000 on stock and shelving. If only half the plants sell before they die, you may lose much of that £3,000. A repair bill for a leaking roof adds a cost you did not plan for.

Cash flow and financial risk

A business also needs cash available to pay day-to-day costs such as wages, rent and suppliers. Poor cash flow, where money comes in slowly while bills are still due, increases financial risk. A business can be owed money by customers and still be unable to pay its own bills on time. The risk is greater when the owner has little savings or backup finance to cover the gap.

Lack of security is the risk of losing the reliable income and financial safety that comes with paid employment. Here, security means financial or job security, not physical security such as protecting a shop from theft.

Leaving a job to start a business means giving up a regular wage or salary. You also give up employee benefits such as paid holiday, sick pay and a pension. The owner no longer knows exactly how much will be earned each month, because sales can be strong one month and weak the next. This makes it harder to plan bills and savings, and a quiet month can leave too little money for rent or household costs.

Financing the business can also put personal savings or assets at risk. An owner might use their own money to buy stock, equipment or a vehicle, or borrow against their home. If the business fails, those savings or assets may be lost.

For example, Nadia leaves her job as a supermarket team leader to run a small dog-grooming salon on the high street. She spends £5,200 of her own savings on grooming tables, dryers and fitting out the rented unit, and she no longer receives paid holiday or sick pay. Bookings are busy in the weeks before Christmas but very thin in February, so her income drops and she has to dip into savings to cover her rent and energy bills. If the salon closes, the £5,200 may never be recovered.

Business success is a reward: it is the positive outcome an entrepreneur hopes to gain from accepting risk, such as achieving the aims they set for the venture, and the reason they are willing to put money, time and effort into it. Success is subjective, which means it depends on what each owner values, so two businesses can look very different and both still be successful.

Ways owners measure success

Why the difference matters

An owner who cares only about profit might call a quiet year a failure, while an owner who wanted more control over their time might call the same year a success because it paid the bills and let them choose their own hours. Neither view is wrong, because success is judged against the goals the owner set.

For example, Marek runs a one-van gardening round. He could earn more by taking on staff and advertising widely, but he wants to finish early enough to collect his children from school. The business makes a modest profit, yet for Marek it is successful because it fits around his family. His neighbour, who runs a mobile dog-grooming service, measures success differently: for her the reward is the day she can afford a second van and an employee, so growth matters more than short hours.

This is why a business with a modest profit that gives its owner control over their working day can still be counted as a success.

Profit is the financial reward left after a business's costs are deducted from its revenue. Revenue is the income a business receives from sales. Costs are the expenses of running the business, such as materials, wages, rent and other bills. For example, a small business selling printed phone cases has revenue of £24,000 from sales. Its costs are £19,500 for blank cases, printing supplies, website fees, packaging and delivery. Profit is £24,000 − £19,500 = £4,500.

That £4,500 rewards the owner for the money they have invested and the time and effort they put into the business. If the owner works in the business, profit can also provide their income. Profit can be kept in the business and used as finance for reinvestment or future growth. The owner might buy a better printer, develop a new product range or open another outlet. This can help the business expand.

Profit is not guaranteed just because a business sells goods or services. It depends on revenue being greater than costs. A business can make sales and still make a loss if its costs are too high. For example, a stall selling handmade candles might take £900 in sales but spend £1,100 on wax, jars, stall fees and transport. It has made a loss of £200, so there is no profit to reward the owner.

Independence is a non-financial reward of running a business: it means you control the decisions and can be your own boss. It can matter as much as financial rewards because you choose what to sell, how to sell it, who to employ and how to organise the working day.

Independence gives personal control and flexibility, which are rewards in their own right rather than financial gain. For example, someone might leave a job at a garden centre to run a mobile plant-care service for offices. They can start at 9am, take bookings around school hours and turn down jobs that do not suit them. They might earn less profit than expected, but accept that trade-off because choosing their own hours and working from home matters to them.

Non-financial rewards are the benefits that do not appear directly in the profit figure, such as personal satisfaction and making a difference. They can be as important as financial rewards. An owner may feel proud of creating jobs, helping the local community or solving a problem customers care about. For instance, the owner of a dog-walking service may feel satisfaction from helping older residents keep their pets exercised, and pride when they hire their first employee. These feelings can motivate an owner to keep going when running the business is stressful, even if profit is modest.

Independence does not mean having no responsibility or risk. You still carry the consequences of your decisions and the risk of financial loss or failure; independence changes who makes the decisions, not whether risk exists.

Reward is the benefit or positive outcome an entrepreneur hopes to gain from accepting a risk. The risk is the chance that things go wrong; the reward is the reason for putting up with that chance. Every decision about starting, running or growing a business involves both.

Why reward matters

The potential for reward motivates entrepreneurs to accept risk. Someone thinking about launching a business weighs the chance of losing their savings against the hope of profit, independence or business success. Without a reward worth aiming for, few people would hand over their money and time when they might get nothing back. Reward is not guaranteed, however — it is only what the entrepreneur hopes to gain.

Balancing risk and reward

Greater potential reward is often linked to greater risk, but a bigger risk never guarantees a bigger reward. A high-risk expansion might bring high profit, or it might bring a financial loss. Entrepreneurs therefore balance potential rewards against possible risks: if the risk seems too high compared with the likely reward, they may delay the decision or take a smaller step first.

Effects on business activity

Risk can discourage start-up or investment: if the chance of loss looks too great, an entrepreneur may never begin, and an investor may keep their money instead. Rewards do the opposite. They encourage enterprise, innovation and growth, because owners are willing to try new ideas, borrow money and expand when the payoff looks worthwhile. Successful entrepreneurs do not avoid risk altogether; they weigh the possible reward against the risk before going ahead.