Risk and reward: the impact of risk (business failure, financial loss, lack of security) and reward (business success, profit, independence) on business activity and on the decisions an entrepreneur makes.

What this dot point is asking

Edexcel wants you to explain how the risks and rewards of running a business affect the decision to start one and how it is run. Every business activity involves taking a risk in the hope of a reward; the entrepreneur's job is to weigh the two.

The risks of starting a business

Business failure is common: many new businesses close within their first few years, often because they run out of cash or cannot attract enough customers. Financial loss follows from failure: the owner loses the money they put in, and if they are a sole trader with unlimited liability, their personal possessions are at risk too. Lack of security is the quieter risk: an employee receives a steady wage and benefits, but an entrepreneur's income depends entirely on how the business does, which can be unpredictable, especially at the start.

These risks shape business activity. Because the downside is real, sensible entrepreneurs reduce risk before they commit: they carry out market research, write a business plan, prepare a cash-flow forecast, and often start small so that a failure costs less. This is why entrepreneurs are described as taking calculated risks.

The rewards of starting a business

Profit is the headline reward and, in economic terms, the payment for taking the risk: if the business succeeds, the owner keeps the profit rather than handing it to an employer. Independence matters to many founders as much as money: they control the product, the hours and the direction. Business success is a reward in itself, the satisfaction of turning an idea into a working enterprise and seeing it grow.

The rewards drive business activity because they are what make the risk worth taking. The larger the potential reward, the more risk an entrepreneur may be willing to accept.

Balancing risk and reward

The decision to start a business is a trade-off. A salaried employee swaps a steady wage for security; an entrepreneur swaps that security for the chance of a larger reward and full control. How much risk is worth taking depends on the strength of the idea, the quality of the research, the type of ownership chosen and the owner's financial cushion.

Try this

Q1. State one reason why a new business might be a financial risk to its owner. [1 mark]

• Cue. The owner could lose the money invested, and with unlimited liability personal possessions too.

Q2. Explain one reward that might persuade someone to accept the risk of starting a business. [3 marks]

• Cue. Profit, independence or success, developed with why it outweighs the risk for that person.