Supporting guidance: Identification of Risks

General
Business
Risks

External environment Internal environment

Market Financial Operational Financial Ethics Compliance Information
risk risk (Business) risk risk risk risk risk
• Economy • Currency • Products • Cash flow • Fraud • Legal • IT
• Environmental • Interest rate • Product generation • Capital • Cultural • Standards • Technology
• Political • Inflation • Product pricing structure • Social
• Technology • Supply chain • Credit performance
• Social • Marketing • Going
• Fashion • Trading Concern
• Stakeholder • Dealer
engagement • Counterparty
• Environmental
• Intellectual property
• Labour
 Supporting guidance: Identification of Risks

Market Risk
Economy This relates to the Country risks of South Africa in which all business
operate. Some aspects that affect the risk are the rising public debt,
inefficient state-owned enterprises, and spending pressures, which
reduces the country’s global competitiveness. Despite this South Africa
has a highly developed economy and advanced economic infrastructure,
making the country the leading African economy and home to 75% of the
largest African companies.
Public debt is over 50% of GDP and the budget deficit is around 4%, as
economic growth slower than expected and revenue collection fell.
The country struggles with socio-economic challenges, such as growth,
high unemployment, persistent social inequalities, a highly volatile
currency, and rising inflationary pressures.
Private investment growth is expected to remain cautious as the
elections approach and uncertainties about land reform continue to be a
cause for concern. The prevailing political uncertainty in the country
seems to have eroded business and consumer confidence.
Environmental This refers to the effect that an entity can have on the natural
risk environment and vice versa.
An entity can have a negative effect on the environment by
generating pollution in the form of effluence or emissions. This may
result in fines levied on the entity or the entity being required to incur
rehabilitation costs. This risk can result in a strategic risk as the
entity's reputation may also be damaged as a result of its effect on
the environment (environmental risk may drive reputational risk).
Environmental disasters can also pose a threat to an entity (such as
floods, earthquakes, cyclones and tornados). These events
hamper the continuity of business, and result in physical damage to
the entity's property and assets.
Political risk This risk relates to actions taken by the government of the day that
may result in financial loss for the entity. Such risks arise in
respect of local and foreign operations.
Examples of political risk include imposing foreign exchange
controls that hamper the flow of funds across borders,
implementing quota systems or import tariffs, the nationalisation of
assets owned by the enterprise, and the strict regulation of merger
and acquisition activity.
This risk can be negative for one party while creating opportunities
for another. For example, local entities can benefit from quota
systems while foreign suppliers will not.
Technology Inability to standardize products across the industry to ensure effective
integration of IT in future.
Inability to achieve seamless integration and communication between
various digital products and platforms including mobile platforms, tablets
and other forms of access

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 IT risks relating to malfunction or disruption in the operation of the
systems, or cyber-security breaches, could adversely impact the
company's ability to compete.

Social This relates to the individuals who are dependent upon the business for
livelihood and how they are affected by certain events. Some of the
aspects that often require assistance from business are old-age, death in
the family, and disabling accidents or illnesses, permanent
unemployment, and the technological redundancy of skills. Other aspects
that may affect households are drought, inflation or a financial crisis.
Fashion risk A key risk for clothing retailers is fashion risk. Put simply, the risk is
that the buyers of clothing retailers misjudge fashion for the next
season. This can result in significant inventory write-offs owing to the
accumulation of obsolete inventory.

Financial risk (external)

Currency risk An entity that enters into transactions with foreign suppliers or foreign
customers and is invoiced or invoices in a foreign currency is
exposed to the effect of adverse movements in the currency before
cash settlement of the transaction (transaction risk).
An entity that has foreign operations or foreign subsidiaries (or any
foreign assets or foreign liabilities, for that matter) runs the risk of
adverse movements in foreign exchange rates from one reporting
date to the next (translation risk).
Currency movements can, however, also drive strategic risk: an
exporter can lose foreign market share if their local currency
strengthens against foreign currencies so that their products or
services become too expensive for their foreign customers
(economic risk).
Interest rate This is the effect that adverse movements in interest rates can have
risk on the amount of interest that is owed on interest-bearing
borrowings and on interest that is received on interest-bearing
investments.
Inflation Also called purchasing power risk, is the chance that the cash flows from
an investment won't be worth as much in the future because of changes
in purchasing power due to inflation.

Operational (Business) Risks

Products Breadth of product range: An entity that sells a narrow range of
products is very dependent on the performance of a small number
of products to generate profits and value. If one of these products
fails in the market, then the entity's profit and sustainability can
suffer.
Quality of the products sold: An entity's reputation can be tainted if
the quality of a product declines. Companies that have to recall
products (as was the case with Toyota) because of defects are
affected by increased costs (cost of reworking or replacement) and
reduced revenue streams, which ultimately leads to reduced profits
and value.
Geographic diversification: Entities whose geographic footprint is
limited to a single area or region may do less business than entities
who diversify the areas in which they do business. The entities that
diversify are exposed to less concentration risk. Remember,

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 however, that as entities diversify, so they become exposed to other
risks, such as currency and political risk.
Product Entities that do not invest in research and development (R&D) are
generation exposed to significant strategic risk. These entities will be unable
to keep up with the product developments of their competitors and
may therefore start to lose market share, revenues, profits and
ultimately value. New products need to be researched and
developed on an ongoing basis to (among other things) replace
aging products.
Entities that do not invest in research and development (R&D) are
exposed to significant strategic risk. These entities will be unable
to keep up with the product developments of their competitors and
may therefore start to lose market share, revenues, profits and
ultimately value. New products need to be researched and
developed on an ongoing basis to (among other things) replace
aging products.
Product An entity's pricing policy largely determines the kind of market
pricing share the entity is able to achieve. An incorrect pricing strategy
could result in the entity pricing itself out of the market and
ultimately place the entity's sustainability at risk.
Supply chain An entity relies on the uninterrupted supply of goods in order for
risk production of goods or the delivery of services to take place. Any
disruption to this supply may mean that the entity is unable to
produce sufficient output to satisfy demand or deliver the required
service, and in so doing may lose customers and profit.
Marketing and The market share a product or service may achieve can be limited
branding by ineffective branding and marketing campaigns. This can also result
in competitors increasing their market share.
Trading risks An entity selling goods locally and/or internationally is exposed to
trading risk, which is comprised of the following three risks:
• physical loss of the goods while in transit
• the risk that the customer will not accept the goods on delivery
(referred to as trade risk)
• liquidity risk in that the entity may not have access to sufficient
funding or liquid resources to enable it to provide credit facilities
to its customers
Stakeholder Best practice dictates that an entity follows a more inclusive
engagement approach when dealing with its stakeholders. Management needs
to conduct stakeholder assessments to identify stakeholders and
their needs. Not engaging stakeholders and failing to consider their
needs during the decision-making process can have a disastrous
effect on a business.
Environmental Environmental risks that may affect a business include:
• extreme temperatures and climate change
• floods, fires and natural disasters
• increases in costs, particularly around energy and water usage, and
waste management
• water restrictions.
Infringing on This risk has an operational and strategic element. An enterprise
intellectual needs to protect its intangible value by as far as possible legally
property protecting its intellectual property (IP) through registering patents
rights and copyrights in its name. It is this IP that the entity uses to create
value on a daily basis and to sustain value more strategically in the
longer term.
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 Labour unrest An entity is at risk if it is unable to recruit the kind of people with the
and other roles required skills it needs or is unable to retain the skills base that it
relating to has. An entity exposed to labour unrest is also at risk.
employees These situations negatively affect the entity's operational
continuity, which in turn can jeopardise the sustainability of the
entity in the long term.

Financial risk (internal)

Cash flow risk An entity is at risk when it does not have sufficient liquid resources
(liquidity risk) to finance its operating cycle, namely extending credit to customers
and paying commitments as they fall due.
In South Africa, the Companies Act views this risk in a serious light
and requires directors to provide an opinion on the company's
liquidity 12 months into the future when making key decisions.
Capital Financial risk is driven by the mix of funding that an entity uses. As
structure more debt is introduced into the entity's capital structure, the risk
that the entity will not be able to service debt repayments increases.
In the terminology used by the Companies Act, this risk ultimately
becomes a solvency risk and needs to be monitored carefully.
Credit risk This is the risk that the entity's customers with credit facilities will
default on future payments, resulting in cash flow problems for the
entity.
Corporate This is the risk that the entity will cease to exist in future. This risk
failure or going can arise as a result of a number of other risks that are discussed in
concern risk this appendix.
Dealer risk Non-performance on the part of the foreign currency dealer from
whom the entity purchases foreign currency or to whom the entity
sells foreign currency.
Counterparty This risk relates specifically to hedging arrangements. It entails
risk non-performance by the counterparty in relation to the hedging
arrangement, in which results in the hedging arrangement
becoming ineffective.
Market risk This is the risk of financial loss resulting from changes in the market
prices of the commodities that an entity buys or sells (specifically
referred to as commodity price risk), or resulting from changes in
the market price of property or financial instruments that were
issued or purchased by the entity.
For example, the investors who bought Facebook shares during the
initial public offering were exposed to market risk as they bought their
shares at a higher price than the price at which the stock traded after
its initial listing.

Ethics risk
Fraud risk Fraud risk results from failures in the internal controls of the business
producing financial losses for the entity. The bigger these losses are,
the greater the likelihood of corporate failure is.
Cultural risk This is the risk of entering a foreign market where the language,
beliefs and customs differ from those to which the entity is
accustomed to locally. The entity will need to understand these
differences, and in particular how these differences affect the
product manufactured and marketed in the new overseas market.
The entity must also know how to customise the product for this
foreign market to appeal to the local community.

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Compliance risk
Legal risk In essence, this relates to the risk of an entity failing to comply with
relevant laws. This risk can result in fines or penalties being levied
on the entity or the entity's licenses being revoked.
Standards/ In essence, this relates to the risk of an entity failing to comply with
regulations relevant formal standards or regulations. This risk can result in
fines or penalties being levied on the entity or the entity's social
image being damaged.
Social The triple bottom line principle requires entities to perform in a
performance way that does not damage the environment, make a profit (a
risk contribution to the economy) and make meaningful contributions
to the people (community and employees). One key aspect is
health and safety in the workplace. Incidents where employees
are injured while working or mortalities occur can negatively affect
the business in terms of cost and disruption to production or
service delivery.
Health and safety issues can therefore pose an operational risk to
the business as well as a strategic risk because work incidents can
negatively effect the entity's reputation (reputational risk).

Information risk
IT risk Authorisation and access control - unauthorised access to sensitive
data/master data.
Backups.
Connectivity to internet.
Technology Technology outdated/not fit for this business.
Breakdown of system / downtime.