Keys to Success: Calculating Risk Vs Reward

Lending institutions in the United States issued loans worth more than $82.6 billion in the year 2016. The more than 5.7 million loans under $100, 000 each are an indicator of the growing number of small and medium-sized ventures in the country. Such is the impact of this new wave of entrepreneurs that SMEs are now creating more than 2 million jobs annually.  

But balancing between risk and reward is often a significant challenge, especially when dealing with startups. Your business acumen may be put to the test in a big way each time you need to make critical investment decisions. So how do you balance risk vs reward as you push your business forward? 

This guide has all the answers you need. 

Risk vs Reward Analysis 

From an economics point of view, a risk is the likelihood that an investment will result in the loss of money. Such an investment may include the purchase of an asset with the expectation that it would earn back returns. But in business, you are never guaranteed that such an investment will yield revenues.

Such uncertainty justifies the need to calculate the possibility of risk before putting in money or resources into a project. But from a business perspective, the assumption is that the greater the risk, the higher the returns. 

With this view in mind, investors still decide to put in resources into ventures that would ordinarily scare most people. Nonetheless, the common denominator in any business decision is the time you are willing to put into such an investment. This assessment of risk justifies the use of the Value at Risk formula in the risk vs reward analysis. 

The Risk Formula

While you can never avoid risk entirely, some standard risk models exist that have stood the test of time. Most successful businesses calculate risk by considering the threat and the consequence. In this commonly used risk formula, companies measure risk by considering the extended period of risk against the investor’s level of confidence.

You can use the Value at Risk (VaR) formula to calculate the risk associated with purchasing an asset or investing in a portfolio. The risk calculator considers your level of confidence in a specific investment vis-à-vis the possibility of the investment making losses. 

Then the outcome is assessed by considering a specific time frame to determine how risky such a venture is for you. Businesses with a confidence level above 85% often expect that even in their worst days, the losses can never exceed 3%.

The Return on Investment (ROI) = Effect x Impact/Cost

Decision making is the bedrock of your business’ success. In action, you are hopeful that the decisions you make within the company will yield the best possible outcome. This is why most successful businesses undertake risk management procedures to test the probable outcomes of certain decisions. 

Are you keen on seeing your business excel? One of the critical considerations you must make is an ROI assessment.

With ROI, you can get the best analysis yet on the risk-reward ratio. This is bearing in mind that the ROI risk calculator considers what you must risk as an investor to gain a return.

Based on this analysis of risk vs reward, you need to ask yourself these three questions before investing.

1. What Is the Total Possible Revenue?

Suppose you take a risk and invest in a specific portfolio, what is the highest probable profits you can derive from such an investment? This question measures the expected return on investment. 

2. What Is the Total Cost You Must Risk Into the Action?

In other words, what are you willing to lose to gain the anticipated returns on investment? This refers to the efforts you are eager to engage to support the venture. They include the fixed and risk-adjusted costs you must incur.

3. What Is the Probable Consequence of the Action?

Suppose this investment decision you’re about to make failed. Would it lead to a state of bankruptcy? You must be able to contemplate the change the action may bring about, whether positive or negative. 

With these three questions answered, it would be easy to make a conclusive decision on how successful a specific investment would be. But first, you need to consider the market and financing for your venture.

Assess the Market 

The market can be an excellent place to begin your assessment. Get to understand the dynamics in the industry. What are the customer’s preferences? What are the barriers to entry?

Once you have an idea of the market and the specific needs of clients, it is possible to determine your risk and reward.  You can start by identifying the target market and their buying potential. The market assessment also prepares you for the shifting trends in the sector based on seasonality.

Identify Your Capital Source 

Money is one of the critical aspects that can break or make your business. You may have the idea, the time and the motivation to take up a venture but lack the funding to support the undertaking. Here is where lending facilities come in handy. 

For significant investments in industries such as telecommunication, accessing loan facilities is a considerable risk. You may face uncertainties about the future of the business, which may limit your confidence to borrow. But with this new understanding of risk assessment and analysis, taking out a loan should not be a scary affair.

All you need to do is to understand the various types of loans. You should then assess your business needs and decide on the loan option that works best for you. That way you’ll minimize the risk of defaulting when the time to payback comes.

Business Is Either An Audacious Adventure Or Nothing At All

You must be willing to risk the unusual for you to reap the extraordinary. Once you understand how to balance between risk vs reward, you won’t be afraid of the cost it takes to achieve specific goals. Don’t let financing be the only hindrance to a bountiful return on investment, a loan may be all it takes to start the journey.

For more business-related posts, go through our other insightful posts.