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Profit Risk
Profit risk is a risk management tool that focuses on understanding concentrations within the income statement and assessing the risk associated with those concentrations from a net income perspective.

Alternate Definitions
Profit risk is a risk measurement methodology most appropriate for the financial services industry, in that it compliments other risk management methodologies commonly used in the financial services industry – credit risk management, Asset liability management(ALM). Profit risk is the concentration of the structure of a company’s income statement where the income statement lacks income diversification and income variability, so that the income statement’s high concentration in a limited number of customer accounts, products, markets, delivery channels, and salespeople puts the company at risk levels that project the company’s inability to grow earnings with high potential for future earnings losses. Profit risk can exist even when a company is growing in earnings, where earnings growth will decline when levels of concentration become excessive.

Description of Profit risk
When a company’s earnings are derived from a limited number of customer accounts, products, markets, delivery channels (e.g.branches/stores/other delivery points), and/or salespeople, these concentrations result in significant net income risk which can be quantified. A loss of a just a handful of customer accounts, a loss in a limited number of products, a loss in a select market, a loss in a small number of delivery channels, and/or a loss in a few sales people can result in significant net income volatility. At this stage, income loss risk is present and the company has reached a level of profit risk that is unhealthy for sustaining net income. The method for quantifying and assessing this potential income loss risk and the volatility it creates to the company’s income statement is Profit risk measurement and management. For financial institutions, Profit risk management is similar to the diversification strategies commonly used for investment asset allocations, real estate diversification, and other portfolio risk management techniques.

Basis of Profit Risk
The concept of Profit risk is loosely akin to the well known "80-20" rule or the Pareto principle that states that approximately 20% of a company’s customers drive 80% of the business. This rule and principle may be appropriate for some industries, but not in the financial services industry. According to ABA’s Bank Marketing Magazine, the term was coined by Rich Weissman who says that the rule is more in line with 10-500 rule, where 10% of a bank’s customer base can produce up to 500% of all bank net income.

Measuring Profit Risk
To measure these concentrations and manage “Profit Risk”, the most important tool for financial institutions may be their MCIF, CRM, or profitability systems that they use to keep a track of their customer/member relationship activities. The data in these systems can be analyzed and grouped to gain insights into profitability contribution of each customer/member, product, market, delivery channels, salespeople. Reports showing the concentrations of net income are used by senior management to show (1) where the concentrations are located in the income statement, (2) at what levels are the concentrations, and (3) at what point do the concentrations predict future earnings losses. Often, these reports examine earnings contributions by deciles (groupings of customers or other units of analysis by 10% increments), illustrating concentrations for each 10% group.