In business, risk is anything that could negatively impact your revenues, reputation, or future operations. When you try a new vendor, you take on risk. Their products or services could be below your standards, and cost you customers. When you expand an existing business line, there’s the risk that new products and services could not sell. Think of business risk in terms of exposure to anything that could cause your company to fail.
Risk is an evitable part of running and growing a business, but smart business owners try to minimize and hedge against it.
Why should small business owners think about risk?
In the midst of ordering stock, talking to your marketing department or managing it yourself, and monitoring your performance, why should you think about risk? Because failing to consider, account for, and protect yourself against risk can leave you even more exposed.
Even taking just five minutes to put together a plan to help you fulfill orders should a key piece of equipment go down could salvage a crisis. Thinking about your company’s weak points, and exposure to risk, helps you form plans to minimize damage.
What are the types of risk?
The risks that your business could face can be divided into four categories; reputational, credit, operational, and strategic. Each risk will have different importance to your business based on your industry, time in business, products, and other factors. Smart small business owners should be aware of all of these risks, think about how they could impact them, and have risk management strategies in place.
Reputational Risk
Damage to your reputation, or how others view you in the community, your industry, and among creditors, can put your business at risk. If someone leaves a poor Yelp review, you could have a harder time attracting new clients. Let’s say your bookkeeper forgets to pay an essential invoice on time; now, your reputation with that vendor has been damaged, and they might not extend you favorable terms on your next order.
Reputational risk addresses the harm that damage to your reputation could cause to your business. In a customer-facing retail environment, it can be particularly important. Restaurants now that one bad review can sink their whole business. Wholesalers might have to worry about reputational risk within their industry, but rarely have to concern themselves with the public’s view of them.
When putting together a risk management strategy, evaluate the importance of your reputation. What would happen if it suffered from bad press? Which stakeholders and customers lean the most upon your reputation? Think about mitigation strategies, whether it’s how you’ll respond to negative online reviews or how you’ll monitor a key employee’s performance to make sure bills get paid on time.
Credit Risk
Credit risk has several components. The first is the risk of non-payment, i.e., what if your customers don’t pay you? For a cash business or one where payment is due immediately upon services or goods being rendered, this risk will have less importance. Businesses that extend credit to their customers, however, will need to manage this risk closely.
The risk of non-payment, and what would happen to your business if several large invoices were past due, is something that you should consider. You can protect yourself from non-payment hurting other aspects of your business by opening a line of credit or business credit card to cover gaps between when you’re paid and when your bills come due. Set thresholds for past-due balances at which you’ll stop supplying a customer or performing work for them. Get firm about collection activities, and try to diversify your income stream so that you’re not too reliant upon one customer for your income.
Another aspect of credit risk relates to your small business’s credit profile and the ability to access credit. Credit risk could take the form of a drop in your credit score, a rise in interest rates, or an unfavorable change in terms. All of these could lead to a higher cost of capital, which eats into your bottom line.
If you need access to a revolving line of credit, or loan, to maintain your business, anything that negatively impacts your credit could hurt your business. Even if you could still access capital, you might pay more for it in terms of interests rates ad fees, and a higher cost of capital would leave you with less to invest in your business.
While you don’t have the power to swing the Federal Reserve’s decisions about interest rates, you can monitor your own credit and work to improve it, if needed. Set up auto-payments on all important credit accounts so that you never miss a payment. Identify key suppliers and vendors with whom you must remain on good terms to stay in business, and always pay them first and on-time.
Operational Risk
Operational risk is the risk that your business could cease operations, either temporarily or permanently. The power goes out, and your plant shuts down, or the warehouse holding your inventory floods. Operational risk can arise if you have inadequate policies, plans, and procedures in place to manage your business when things go wrong, or to protect against human error.
Accounting for this risk could be as simple as purchasing a back-up generator; other times, it may involve soliciting quotes from different vendors who could cover for a key supplier in a pinch. Insurance can help you recoup losses from plant downtime or closures, and is often part of an operational risk strategy.
Accounting for operational risk means looking at important moments in your production process or business work flow, identifying where hiccups could occur, and devising a plan to address a potential issue.
Strategic Risk
Strategic risk might be the hardest risk to protect against. It’s the risk that your business strategy won’t pay off, and that your business plan could fail. The best way to protect against this risk is to have several trusted advisors, including your accountant, evaluate your business plan.
Look at all of your business plan’s components, from planned growth to a projected budget, and ask yourself at each step of the process what would happen if something failed. Ask yourself “what if” questions to determine how you could pivot to keep the business on track in a worst-case scenario. Many businesses put together three simultaneous business plans, once for a different percentage of projected growth.
As you put your plan into action, schedule periodic reassessments of your business’ performance to plan. Reevaluate it if results aren’t coming in as expected. Reevaluation could involve scaling back expansion, cutting a product, or responding to increased demand in an unexpected area. This will help you identify potential problems and areas for succes, whether internal or external, and shift to address them.
The final word on risk
Anyone who opens a small business has a certain comfortability about risk-taking. Calculated, measured risks can grow your business and produce great success. While you can choose which of those risks to take on, some risks come from outside forces that you can’t control. In that case, you can decide ahead of time how you’ll respond to them. There’s nothing worse than being caught off-guard in the moment. By considering risks that confront your business, planning for them, and putting together a risk management strategy, you protect your future from the unknown.