What is risk management?
The International Risk Management Institute defines risk management as “the practice of identifying and analyzing loss exposures and taking steps to minimize the financial impact of the risks they impose.”
A risk management strategy, then, works to protect your business from internal, external, strategic, reputational or operational risks.
Creating a plan for mitigating those risks helps organizations prepare for the unexpected and minimize extra costs. But not all risks are negative. According to the Small Business Administration (SBA), risks can also arise from opportunities. For example, expansion and growth are exciting opportunities, but they can also pose additional risk if mishandled.
Risk management’s ultimate goal is to prevent or minimize any negative impact on your business.
Why is risk management important?
Risks are present in day-to-day life. This omnipresence means that, without considering the threats that may be involved in any given business activity, it’s difficult to keep planning under control.
The SBA explains that the positive outcomes of risk management are all linked together: good cash flow leads to stability, which leads to good credit, which leads to longevity.
Risk management also:
- Increases the probability of business success by helping to prepare for the unexpected
- Saves time and guides decision-making because it gives a go-to framework for determining which business opportunities to pursue and which to avoid
- Helps make you a better business owner
Types of risks
There are many threats to a business’s capacity to achieve its financial goals, and they generally fall into five categories.
1. Financial risk
While most risks can financially affect your business, this type of risk refers specifically to cash flow. For example, having a large portion of your revenue coming from just one customer, or incurring a lot of debt, can jeopardize your liquid assets.
2. Strategic risk
Strategy risks, according to Harvard Business Review, are those a company voluntarily assumes in order to generate greater returns. Every
opportunity, even potentially lucrative ones, carries risk. Having a risk management plan in place beforehand helps you decide whether an opportunity is worth the leap, or whether the payoff doesn’t outweigh the exposure.
3. Reputation risk
If your reputation is tarnished, you risk losing customers, brand loyalty, sponsors, suppliers and even employee morale. For small businesses especially, this type of risk is subject to online reviews, such as Glassdoor, Yelp and Facebook.
4. Hazard risk
When discussing risk, hazard is often the first to come to mind. It includes common threats such as property risk, legal liability and workers’ compensation. Examples include building fires, storm damage, and employee illness or injury.
5. Operational risk
From technology to employees, operational risks involve anything that could impact internal, day-to-day activity. Some threats to operations include technical failures, such as a server outage; process failures, such as lack of cash control among employees; and human error, such as incorrect data entry that leads to a product shortage.
How to identify risks
1. Identify the risk
Gather your team and brainstorm any potential risk, from customers to equipment. The SBA also recommends investing in a business plan to help you “look at anything that could halt, slow, or affect the profit of your business.” Once you have identified risks, categorize them as to what may present the most threatening growth obstacles to your business.
2. Analyze the risk
Now consider the impact each risk has on business operations, continuity and future growth. You could conduct a strengths, weaknesses, opportunities and threats (SWOT) analysis with your team to uncover internal strengths and weaknesses as well as external opportunities and threats. Now, evaluate the probability and potential consequences of each risk on your list, and rank them as low, moderate or high so you can prioritize which risks to respond to first.
3. Evaluate risk management options
Start with your highest-ranked risks, and choose whether you will respond by avoiding, mitigating or transferring them. For example, as a customer-facing business, you couldn’t altogether avoid the risk of customers coming into your store. But you could mitigate the risk by controlling for the type of flooring you have to prevent a slip and fall incident. As a restaurant making deliveries, you could transfer your driving exposure to a food delivery service. For some risks, you could transfer liability to an insurance company.
4. Select how to manage risk
Now it’s time to put your plan into action. In the above example about preventing customer slip and falls, your implementation plan could be to call a flooring contractor at 9 a.m. on Thursday to choose your flooring and then schedule the install date.
5. Monitor and review the risk
Set one or several check-in dates to assess how your plan is working and to make adjustments. For example, if you chose to remove your driving exposure, is the food delivery service you chose successful, or do you need to try a different service? Remember, don’t stop at identify. It’s important to lay out your next steps with accountability to ensure your business responds to each threat, and then continue to monitor and review the risk.
Insure against risks
As part of creating a solid risk management plan, it’s important to insure against the risks you’ve identified.
When it comes to finding the right insurance for your small business, the Insurance Information Institute recommends talking to an insurance professional who knows your industry, comparing rates, evaluating insurers to make sure they are reputable and licensed, and implementing your risk management strategy.
To find out how much business insurance will cost you, get a customized small business quote from Nationwide and discuss your risk management plan with your agent.
For more small business resources, don’t forget to visit the Nationwide Business Solutions Center.