Risk and reward in business enterprise

Would you swap a steady job for a burger van? Imagine you are twenty-six, earning twenty-eight thousand pounds a year in a steady job. You get sick pay, holiday pay and a pension, and you have ten thousand pounds saved. You could hand in your notice and open the burger van you have dreamed about for years. If it works, you could earn more than you do now and answer to nobody. If it fails, your savings are gone and there is no job to go back to. Do you jump? Both sides of that choice can be weighed up properly.

Risk is the chance that things go wrong, so that money is lost or the business fails. Reward is what the entrepreneur gains if things go well. The two travel together. A bigger risk usually comes with the chance of a bigger reward, and that chance is why people take it. Picture a set of kitchen scales. The risks go in one pan and the rewards in the other, and the entrepreneur's decision follows the heavier pan. Every business also faces uncertainty, which means nobody knows for sure what customers, rivals, costs or the economy will do next. That is as true for a firm that has traded for a hundred years as for one opening tomorrow. Now a check on the pair. Three students each write one sentence about risk and reward. A: risk is the profit a business makes. B: risk is the chance of losing money, and reward is what is gained if it succeeds. C: higher risk always brings higher reward. Which is right? B is the one. A swaps risk for profit, which is a reward. Now the reason behind that check. Why is C wrong, when risk and reward do travel together? Because of the word always. A bigger risk brings the chance of a bigger reward, never a promise of one. One examiner's report says only one third of students chose the right answer on a multiple-choice question about risk and reward, with the wrong answers evenly spread, which it says shows a lack of understanding of the idea. The fix is to hold the two definitions apart: risk is what could be lost, and reward is what could be gained.

The risks of starting a business come in several kinds. Business failure means the business closes. Financial loss means the owner's savings, or money they borrowed, are lost. Low sales means fewer customers buy than expected. Unexpected costs are bills nobody planned for, such as a broken oven. Unexpected events are things like a flood, a supplier collapsing, or a pandemic. And lack of security means the entrepreneur no longer has a secure, regular income. An employee gets a salary every month, sick pay, holiday pay, and an employer paying into a pension. The entrepreneur loses all of those, and their income goes up and down with the business. Now lack of security in a case. Priya left her job as a payroll officer, where she earned one thousand nine hundred pounds a month, to open Thread and Needle, a clothing alterations shop. Which of these is lack of security for Priya: A, a break-in at the shop, or B, no sick pay if she falls ill? B. Security here means a secure, regular income, so a break-in is a different kind of problem altogether. One examiner's report says this question was designed to be challenging, as many students did not understand the risk of lack of security. It adds that weaker answers saw the word security and assumed it meant the danger of the truck being robbed, or the employees threatened by customers. The habit that avoids it is to open with no secure, regular income, and to build every point from there. Here is how that works for Priya. In her old job, she got one thousand nine hundred pounds every month. Now her income depends on how many alterations come in. A busy June might bring her two thousand four hundred pounds, and a quiet January six hundred. Take six hundred from one thousand nine hundred, and January is one thousand three hundred pounds below her old salary. Which means she may struggle to pay her rent in the quiet months, and have to dip into her savings. Now the second chain is yours. What does having no sick pay mean for Priya if she is ill for two weeks? The shop is shut and Priya earns nothing for those two weeks. Which means there is pressure on her to work even when she is unwell, and holiday pay is gone in the same way. The last chain is the pension. No employer pays into one for her now. She has to save for her own retirement, out of an income that goes up and down. Each chain takes one part of lack of security to its effect on Priya. Saying the same risk again in different words adds nothing, so take one risk further instead.

The rewards sit in the other pan of the scales. Business success means the business survives and grows. Profit is the financial reward, money left after the costs are paid. Independence means being your own boss. And there are non-financial rewards, such as satisfaction, building something new, and good feedback from customers. Now to someone who took the plunge. Callum used fifteen thousand pounds of his savings to open Gamers' Den, a cafe where customers play retro video games. Which is a non-financial reward the case supports: A, becoming famous, B, the satisfaction of turning his hobby into a place people meet to play, or C, profit? B. Profit is a financial reward, and nothing in the case points to fame. Satisfaction, and good reviews from the people who play there, come straight from the case. One examiner's report says some students chose inappropriate rewards, such as fame, which could not be credited there. The way to avoid it is to take your reward from the case. The matching financial risk comes from the case too. If too few customers come, Gamers' Den may not cover its rent and costs, and Callum could lose the fifteen thousand pounds he put in. Taking a risk well means weighing two things against the reward: how big the loss could be, and how likely it is. A calculated risk is one taken after that weighing. Risk and reward shape what a business does: whether it launches, borrows, expands or holds back. In a company, the owners are shareholders. If a risk pays off, profit rises. Dividends, which are their share of the profit, can grow, and their shares are worth more. Now turn it round. If the risk goes wrong, what happens to profit, dividends and the value of the shares? They move the other way. Profit falls, dividends can be cut, and the shares lose value.

A business can reduce its risks before it commits. It can test the idea small first, research the market, write a business plan, and keep its costs and borrowing low. It can insure against unexpected events, sell more than one product, and choose a legal form with limited liability, which has its own video later in the course. Here is Callum again, before he signed a five-year lease on the cafe at one thousand two hundred pounds a month. Explaining a method means saying how it cuts the risk. First, the size of that lease. One thousand two hundred pounds a month, times twelve, is fourteen thousand four hundred pounds a year. Times five years, that is seventy-two thousand pounds he is tied into. Now a different question. Before signing that, how could Callum find out whether enough people will pay to play? He could test the idea first, running Gamers' Den as a pop-up at weekend markets for two months. That shows how many people pay to play, and how much they spend. Which means if demand turned out to be low, he would have lost only the cost of the pop-ups, instead of being tied into a lease he cannot afford. Compare this answer: reducing risk is good because the business is less likely to fail. That says why lower risk is good. It never says how the method lowers it. One examiner's report says a question asked how the risk would be reduced, not the advantage of reducing risk, and some students explained the benefits instead, so they gained no development marks. So start from the method and say what it does to the risk, step by step. Now a method of your own for Callum. His cafe is full of games consoles worth thousands of pounds. How could insurance reduce one of his risks? Take your pick of risk, and hold on to your reason before I show you. He pays a regular premium, a fee to the insurer. If a fire or a break-in destroys the consoles, the insurer pays to replace them, which means one unexpected event does not wipe out his savings.

Over to you now. Five questions on risk and reward, and the answer after each.

What is the difference between risk and reward?

Risk is the chance of losing money or the business failing. Reward is what is gained if it goes well.

Now one word that gets misread. What does lack of security mean for an entrepreneur?

No secure, regular income: no fixed salary, sick pay, holiday pay or employer's pension.

Now a new case. Mo quits driving buses to run a phone-repair stall. How could lack of security hit him?

For example, there is no sick pay. If Mo is ill, the stall stays shut and nothing comes in.

Another new case. A florist opens her own shop. What is one non-financial reward she could get?

Satisfaction from building something of her own, or customers coming back to thank her. Anything that fits her shop, never fame.

Now the how. How does testing an idea small reduce the risk?

It shows real demand before the big costs are signed for, so less is lost if demand is low.

So back to the burger van. On one side sit ten thousand pounds of savings and the security of a salary. On the other sit profit, independence and the satisfaction of building it. You could cut the risk before you jump: keep the job, and run the van at weekend markets first. If it sells, the jump is smaller. If it does not, you have lost a few weekends, and your ten thousand pounds is still yours.

If lack of security is clear to you now, give this a thumbs up, because you own this one. If not, leave it without one. If that felt fast, that's normal, because there was a lot in it.

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