A Small Business Owners Guide to Risk Management

Risk is part and parcel of any business operation. Starting a business in the first place is a risky affair — you can never be sure whether the venture will be successful or not.  Almost 20 percent of new businesses fail within one year, according to the Small Business Administration. Aside from internal risks inherent in all businesses, there are many external risks that are beyond your control.

All types of risk can be managed, and their adverse outcomes mitigated using proven risk management strategies. Even so, it’s fallacious and unrealistic to think that you can eliminate risk from your operational setup. As a business owner, it’s best to keep in mind that “risk management” isn’t just about purchasing insurance protection — while insurance is necessary, there can be  a lot more to do to protect your business. Here’s a risk management guide for small business owners.

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What Common Risks do Small Businesses Face?

Here are the most common types of risks that a small business is likely to face:

Financial Risk

This type of risk has direct implications on how your venture handles its finances. For instance, new businesses should be keen on the customers they extend credit to, their debt loads, and current foreign exchange rates. Competition and market risks are also regarded as financial risks since they directly affect your business costs and profits. From the start, you should identify the financial risks that your small business encounters so that you create practical mitigation strategies.

Operational Risks

Typically, these risks arise from internal failures. This implies weaknesses in your business processes, system failure, and human error. Unlike the case with financial risk, there’s no return on operational risks. In some instances, operational risks arise from unexpected external events, including supplies shortages and transport interruptions.

Reputation Risk

Reputation is everything for your small business, irrespective of the industry you’re in. If your reputation gets tainted, there will likely be an immediate decrease in profit since clients will be wary of buying from you. Likewise, reputation loss has other effects. For instance, employees can get demoralized and decide to leave. It will also be difficult to hire quality replacements since potential candidates who have had about the company’s bad reputation will be hesitant to join your team.

Compliance Risks

Regardless of the industry you operate in, there are numerous compliance standards that you must meet. Compliance risks are linked to legislative statutes and regulations that govern businesses operating in your industry. They include data security laws, employee protection regulations, and environmental protection laws. Failure to comply with any of these regulations puts your business on a collision path with regulatory bodies as well as state and federal agencies. Indeed, this is a risk that every small business owner should strive to avoid.

Creating a Risk Management Plan

After identifying your company’s risk categories, you should create a risk management plan that outlines how to deal with each risk. It’s best to ensure that your risk management strategy addresses risks that are specific to your organization. Here are the steps for developing a risk management plan:

  • Identify risks inherent in your business
  • Assess the risks
  • Manage the risks
  • Monitor and review your risk management plan

Identifying Risks

You can’t create a risk management plan for your small business if you don’t have an idea about the risks that you face. Therefore, you should start by undertaking an in-depth review of your operational setup to identify potential risks. Here are some handy techniques for identifying risks:

  • Assess all aspects of the business to identify areas that could negatively affect operations such as product development and marketing
  • Examine records such as complaints and safety incidents to pinpoint previous problems
  • Consider external threats that can impact on the business
  • Brainstorm with employees and other stakeholders

Risk Assessment

Risks can either be negative or positive. Negative risks hurt your business. They include compliance risk, security and fraud risk, reputation risk, and financial risk. These risks should be mitigated so that their impact is limited. Projects completed well under budget, or the success of untested marketing strategies are some positive risks that you may encounter. You should use such risks to your advantage and grow your business in the process.

To assess the risks that you identified earlier, establish the likelihood of their occurrence and possible consequences. Risk assessment helps you determine your vulnerability to each risk. It enables you to quantify risks that are worth worrying about and those that can be overlooked. As a result, you’ll also determine the risk level of each risk and how to control them. Risk control measures may include elimination, substitution, administrative control, and engineering control.

Managing Risk

Generally, risk management entails formulating a cost-effective and scalable strategy for dealing with potential problems that you may face. Some of the effective options you can use to manage your risks include avoidance, reduction, acceptance, and transference. The choice you make should depend on the risk level.

After identifying a risk, you can avoid it by changing your business process, material, or equipment to achieve the targeted outcome, albeit with less risk. If you can’t avoid the risk, you should create a strategy for reducing its likelihood and consequences. This may include employee awareness, documenting policies and procedures, compliance with regulations, contingency planning, and safe record keeping.  

You can also manage your risks by transferring them in bits or wholesomely to another party through insurance, joint ventures, and contracting. In case you can’t avoid, reduce, or transfer risk, you’ll have to accept it. Risk acceptance doesn’t imply that you’re giving in to risk. Instead, it means you acknowledge that you can’t eliminate the risk, but you have implemented mitigation measures.

Prepare Contingency Plans

In today’s dynamic business environment, the occurrence of risk is a matter of ‘when’ rather than ‘if.’ Contingency planning involves more than drawing a risk management strategy. It also entails creating a recovery plan, bearing in mind that risks can become realities anytime. Contingency planning could involve the following:

  • Implementing policies for ensuring employee safety when disaster hits
  • Installation of a security system to avert property losses
  • Shunning transactions with suspicious potential customers and vendors
  • Continuous employee training so that everyone understands their roles in preventing risks from becoming events

Monitor and Adapt as Required

As your business grows, it faces new types of risks. Therefore, your risk management plan shouldn’t be stagnated. Instead, it needs to be scalable so that it supports the growth of your business. Moreover, it’s best to update and review it regularly to reflect your company’s current conditions. Ideally, a risk management plan should be reviewed biannually. Review meetings should include the business owner, department heads, and, if possible, an independent risk management consultant.

To prevent the financial losses that typically arise when risks become realities, it’s best to purchase an insurance cover your small business. Contrary to what you may think, an insurance cover is a core component of risk management since it shields you from legal and financial liability if a disaster happens. It also covers property and damage losses.

Key Takeaways

As a small business owner, risk is one of the occupational hazards you should be wary of when launching your venture. Risk comes in different forms, and can either be internal or external. Although you can’t escape business risks, there’s so much that you can do to mitigate them and manage their consequences.

About Mohit Tater

Mohit is the co-founder and editor of Entrepreneurship Life, a place where entrepreneurs, start-ups, and business owners can find wide ranging information, advice, resources, and tools for starting, running, and growing their businesses.