Why Risk Management Is Important to Small Business and How to Manage it for Growth
Risk is inherent to every part of a business. Companies need to take risk in order to grow, become profitable, and contribute to the economy. Risk management is the practice of identifying, analyzing, understanding, and controlling risk, helping to ensure capital and earnings are maintained. Risk management applies to all aspects of a business and all company sizes. Risks can be classified as Internal (weaknesses) or External (threats). In general terms, internal weaknesses can be managed and controlled, but often, external threats may be out of a business’ control.
It is important to remember that risks do not always come from negative sources or events. Risks can also originate from positive sources such as company growth or opportunities. When companies grow and expand, they may face new and different risks. The goal of risk management is to minimize the risks a company faces and must manage. Below are some examples of internal and external Risks.
Human Risk/Employees – The risk that your employees cannot perform their jobs effectively, or risks of loss due to illness, absenteeism, death, morale, theft, fraud, etc.
Technology – The risk your company faces with the IT structure, i.e., is your operating software at the end of its usable life, or are your IT service providers stable and reliable, etc.
Operations – An example of an operational risk would be not having contract limits or pricing levels that your sales department is authorized to execute without approval, or using a system that does not enforce assigned credit limits for customers.
Physical Assets – The risks faced when your physical assets are threatened due to damage, theft, age, maintenance, downtime, etc.
Economic Pressure – These are the risks faced by the general economic condition. If the economy is declining, there may be downward pressure on pricing or increased costs for raw materials.
Natural Disasters – The consequences of a natural disaster can devastate a company in a matter of hours. Maintaining operations under such conditions needs to be balanced with employee safety remaining a top priority.
Political Risk – The risk faced as a result of political decisions, events, or conditions will significantly affect the profitability of a business entity or the expected value of a given economic action.
Competitor – Your competitors can make changes that can negatively impact revenue and margins. They could engage in a price war to win market share, or acquire other companies that offer different services and products and create a package offering you cannot offer customers.
Disruptive Technology – The risks faced by companies that new and emerging technology will require them to alter the way that they approach their business, or risk losing market share or becoming irrelevant.
In managing all risks, step one is to create a Risk Management Plan. There are 5 parts to creating such a plan. These items listed below create a process that should be updated at least annually to keep a company’s risk management plan up to date.
Risk Identification – The company needs to perform an assessment and identify the risks that it faces.
Risk Analysis – What are the odds that the risk occurs, and what are the consequences.
Risk Assessment and Evaluation – Companies need to determine the level of acceptability of risk across all areas when compared to the risk appetite.
Risk Mitigation – A company must develop a plan to assess the highest-level risks and how to alleviate them using risk controls and processes. This part of the process also needs to include contingency planning on how to handle the highest-risk situation if it occurs.
Risk Monitoring – The risks need to be continually monitored and measured. Companies need to develop the means to track their own particular threats for the purpose of adequate evaluation.
Now that we know what a risk management plan is, and the analysis we need to perform in order to create one. How does a company actually manage risk? What actions can a company take to manage and mitigate risk?
Risk Management Approaches
Risk Avoidance – Completely avoiding all risk is not feasible, but companies can create a strategy to deflect certain risks that are found to be intolerable.
Risk Reduction – Companies are sometimes able to reduce risks. This is achieved by creating or adjusting a process, or reducing the scope of work performed for a client.
Risk Sharing – The ability to share a risk with a third party, such as a vendor who is working with you to complete a project.
Risk Retaining – A conscious decision to accept the risk, as the expected return is high enough to warrant taking on the risk.
Managing risk can be expensive, but it is critical to ensure the stability and enable a business to grow and prosper. This is where outside help can be key for a small business, as most small enterprises cannot afford a full-time risk management employee.
Small business owners need to find a great insurance broker and a great attorney. The insurance broker will help ensure a company’s risks are managed to the best extent possible through purchasing insurance. A good attorney can help the business draft contract language that can be used to manage risk through establishing clear limits in contract language. Whether it is contract language used for clients or vendors, it is important to establish limits, as this can be beneficial to all parties in a contract.
A fractional CFO can be a vital source in helping small business owners pick the best insurance providers and attorneys, as they have depth of experience in dealing with these complex situations. CFO Shield in the business of helping small business to understand the market place, create the strategic plan, execute that plan, and achieve the prosperity that is your goal. We leverage our offerings and enable small businesses to solve problems and share in the same economies of scale that larger companies enjoy. We have the experience needed to create customer-centric solutions to help small business owners better manage their back office and help them formulate strategies to adequately manage working capital, thereby ensuring stability and prosperity.
To find out more, visit CFOShield.com.