RISK AND UNCERTAINTY- ALL YOU NEED TO KNOW
Uncertainty simply means the lack of certainty or sureness of an event. In accounting, uncertainty refers to the inability to foretell consequences or outcomes because there is a lack of knowledge or bases on which to make any predictions
The term is often widely used in financial accounting, especially because there are many events that are beyond a company’s control that can greatly affect its transactions. Since it is much harder to make financial decisions during times of uncertainty, many company owners refrain from making one to avoid creating problems.
For example, let’s say that a business can earn 10% or 20% of profit within the next two years. However, it is uncertain because we cannot measure it. So, there is a kind of probability attached to uncertainty which is improbable in the case of risk.
In the ordinary sense, the risk is the outcome of an action taken or not taken, in a particular situation which may result in loss or gain. It is termed as a chance or loss or exposure to danger, arising out of internal or external factors, that can be minimised through preventive measures.
In the financial glossary, the meaning of risk is not much different. It implies the uncertainty regarding the expected returns on the investments made i.e. the probability of actual returns may not be equal to the expected returns. Such a risk may include the probability of losing the part or whole investment. Although the higher the risk, the higher is the expectation of returns, because investors are paid off for the additional risk they take on their investments. The major elements of risk are defined as below:
- Systematic Risk: Interest Risk, Inflation Risk, Market Risk, etc.
- Unsystematic Risk: Business Risk and Financial Risk.
- If the income falls down below a certain mark, it is a risk for the company.
- If the business grows 10% instead of the projected 20% rate, that is also a kind of risk for the company.
Differences Between Risk and Uncertainty
- The risk is defined as the situation of winning or losing something worthy. Uncertainty is a condition where there is no knowledge about the future events.
- Uncertainty refers to a process where the future outcome is largely unknown. Therefore, the probability of an outcome is also unknown in the case of uncertainty. Risk, on the other hand, has a certain probability of occurring in the future. Therefore, risk can be measured and acted upon, while uncertainty cannot be treated so.
- Risk can be measured and quantified, through theoretical models. Conversely, it is not possible to measure uncertainty in quantitative terms, as the future events are unpredictable.
- The potential outcomes are known in risk, whereas in the case of uncertainty, the outcomes are unknown.
- Risk can be controlled if proper measures are taken to control it. On the other hand, uncertainty is beyond the control of the person or enterprise, as the future is uncertain.
- Minimization of risk can be done, by taking necessary precautions. As opposed to the uncertainty that cannot be minimised.
- In risk, probabilities are assigned to a set of circumstances which is not possible in case of uncertainty.
- The first difference as mentioned above is that risk is measurable, while uncertainty is not measurable.In the case of risk, there is a process through which it can be measured; while in the case of uncertainty, there is no such measurement process.