Risk is a necessary part of growth, although risk management is often overlooked by small business managers. Strategic risk management is just as critical for a start-up, small or growing business as it is for a large, established one.
Know the different risk types
According to Huffington Post, there are four main types of risk: market risk, credit risk, operational risk and reputational risk. Each of these risk types should be managed in distinctive ways.
Managing market risk
Market risk refers to “economic and environmental factors”[Source] such as currency fluctuation, trade laws and the changing prices of goods, among other factors. Managing market risk means monitoring external influences. A good way to start is to make a list of all the external influences that could affect your business.
Managing credit risk
Credit risk relates to outstanding debt. This risk can materialise “when your customer or vendor defaults on paying you.”[Source] You can manage your credit risk by not relying too heavily on one customer, expanding your customer base and securing various streams of income.
Managing operational risk
Operational risk includes the risk of financial losses due to ineffective systems or processes. An example of a risk resulting from problematic internal processes would be fraud. Monitoring, controlling and reviewing internal and external processes can help contain operational risk. Having defined roles and duties can also help in this regard.
Managing reputational risk
Reputational risk looks at the public perception of your business. Negative publicity and loss of credibility are risk factors that can result in financial losses. PR officers can be instrumental in helping your business maintain a favourable public image. It’s also important to be clear about what your business stands for. Communicate this to your staff and customers so that it’s entrenched in your company culture.
Identify, rank and quantify your risks
Identify the risks
Identifying the risks particular to your business is an important process. Have a look at other businesses in your industry that are similar to yours. Ask yourself what their biggest risks are and find out how they protect against those risks. While your business may have a few unique risk factors, there will also be some common ones.
Some of the common risks identified by American Express include:<
- The loss of property (due to circumstances like crime)
- Business interruption loss (where your business activities are interrupted due to a fire, flood, etc.)
- Injury to employees while they are at work
- Key person loss (where a significant member of the business falls ill or dies)
Rank the risks
Some risks are more worrying and potentially more costly than others. Once you’ve identified and listed your risks, the next step is to rank them in order of priority and probability. Smart risk management means evaluating which risk factors could be the most detrimental to your individual business. Here are a few examples:
- For a small business, key person loss can be extremely harmful, as every employee is critical. A possible solution is to train your staff members well so that they can replace key persons if necessary.
- High tech companies with expensive equipment should prioritise security (alarm systems, cameras, security guards) because their assets are so valuable.
Quantify the risks
Be careful about paying extremely high coverage costs for risks that wouldn’t cost too much to manage should they occur. Calculate or estimate how much each risk element could cost you, should the worst happen. This should help clarify how to approach each risk smartly and strategically.
Decide on a strategy
According to Entrepreneur, there are a number of approaches you can consider to determine the most economically viable way of handling risks:
Assuming the risk would mean taking on the financial risk to your company. You could do this when protecting against the risk would work out to be more expensive than handling the potential fall-out. Alternatively, this approach might make sense if the risk is highly improbable, for example, serious injuries in a small IT firm.
Avoidance refers to “removing the cause of the risk”[Source]. This could mean removing a hazard and preventing an accident from happening. The removal cost could work out cheaper than dealing with the effects it might have later.
Loss reduction is the “transfer of the risk to another party” [Source].
You can manage risk in this way by contracting out a process or a service to another person or business so that the risk and responsibility is shifted. This can be done with transportation or security, among other services.
Update and review
While insurance is the most basic and obvious of measures, risk management is more complex than that and should be added to and reviewed consistently. For small business owners particularly, reviewing and updating your risk management strategy is important because your business may still be growing.
As your business grows, your risk factors will change and your risk management plan will need adapting. There are two main rules for maintaining the best risk management strategy for your small business:
- Stay up-to-date with market trends, changes in the economy and developments in your industry.
- Review your risk management strategy at least twice a year.