Business Risks: Do you know yours?
Businesses face all kinds of risks, some of which can cause serious loss of profits or even bankruptcy. But while all large companies have extensive “risk management” departments, smaller businesses tend not to look at the issue in such a systematic way.
Risk means that there is a chance that you won’t receive a return on your investment. It is an exposure to danger to your bottom line. When you are in business, you need to consider the kinds of events that could pose a risk to your business and take steps to mitigate them.
We will go over a series of articles to understand the types of risk, along with ways to manage and apply tactics to avoid or mitigate the impact they may have to your business.
So first we’ll examine the main types of risk your business may face. You’ll get a rundown of strategic risk, compliance risk, operational risk, financial risk, and reputational risk, so that you understand what they mean, and how they could affect your business.
Everyone knows that a successful business needs a comprehensive, well-thought-out business plan. But it’s also a fact of life that things change, and your best-laid plans can sometimes come to look very outdated, very quickly.
This is strategic risk. It’s the risk that your company’s strategy becomes less effective and your company struggles to reach its goals as a result. It could be due to technological changes, a powerful new competitor entering the market, shifts in customer demand, spikes in the costs of raw materials, or any number of other large-scale changes.
History is littered with examples of companies that faced strategic risk. Some managed to adapt successfully; others didn’t.
Are you complying with all the necessary laws and regulations that apply to your business?
Laws change all the time, and there’s always a risk that you’ll face additional regulations in the future. And as your own business expands, you might find yourself needing to comply with new rules that didn’t apply to you before.
For example, let’s say you run an organic farm in North Carolina, and sell your products in grocery stores across the U.S. Things are going so well that you decide to expand to Europe and begin selling there.
That’s great, but you’re also incurring significant compliance risk. European countries have their own food safety rules, labeling rules, and a whole lot more. And if you set up a European subsidiary to handle it all, you’ll need to comply with local accounting and tax rules. Meeting all those extra regulatory requirements could end up being a significant cost for your business.
Even if your business doesn’t expand geographically, you can still incur new compliance risk just by expanding your product line. Let’s say your North Carolina farm starts producing wine in addition to food. Selling alcohol opens you up to a whole raft of new, potentially costly regulations.
And finally, even if your business remains unchanged, you could get hit with new rules at any time. Perhaps a new data protection rule requires you to beef up your website’s security, for example. Or employee safety regulations mean you need to invest in new, safer equipment in your factory. Or perhaps you’ve unwittingly been breaking a rule, and have to pay a fine. In the USA you have those rules imposed by the Occupational Safety and Health Administration (OSHA), or environmental concerns like those covered by the Environmental Protection Agency (EPA) or even state and local agencies.
All of these things involve costs, and present a compliance risk to your business.
In extreme cases, a compliance risk can also affect your business’s future, becoming a strategic risk too.
Most categories of risk have a financial impact, in terms of extra costs or lost revenue. But the category of financial risk refers specifically to the money flowing in and out of your business, and the possibility of a sudden financial loss.
For example, let’s say that a large proportion of your revenue comes from a single large client, and you extend 60 days credit to that client.
In that case, you have a significant financial risk. If that customer is unable to pay, or delays payment for whatever reason, then your business is in big trouble.
Having a lot of debt also increases your financial risk, particularly if a lot of it is short-term debt that’s due in the near future. And what if interest rates suddenly go up, and instead of paying 8% on the loan, you’re now paying 15%? That’s a big extra cost for your business, and so it’s counted as a financial risk.
Financial risk is increased when you do business internationally. The impact of fluctuation in raw material costs is increased when involving international currencies.
Your own company is also a source of risk.
Operational risk refers to an unexpected failure in your company’s day-to-day operations. It could be a technical failure, like a server outage, or it could be caused by your people or processes.
In some cases, operational risk can also stem from events outside your control, such as a natural disaster, or a power cut, or a problem with your website host. Anything that interrupts your company’s core operations comes under the category of operational risk.
While the events themselves can seem quite small compared with the large strategic risks we talked about earlier, operational risks can still have a big impact on your company. Not only is there the cost of fixing the problem, but operational issues can also prevent customer orders from being delivered or make it impossible to contact you, resulting in a loss of revenue and damage to your reputation.
There are many different kinds of business, but they all have one thing in common: no matter which industry you’re in, your reputation is everything.
If your reputation is damaged, you’ll see an immediate loss of revenue, as customers become wary of doing business with you. But there are other effects, too. Your employees may get demoralized and even decide to leave. You may find it hard to hire good replacements, as potential candidates have heard about your bad reputation and don’t want to join your firm. Suppliers may start to offer you less favorable terms. Advertisers, sponsors or other partners may decide that they no longer want to be associated with you.
Reputational risk can take the form of a major lawsuit, an embarrassing product recall, negative publicity about you or your staff, or high-profile criticism of your products or services. And these days, it doesn’t even take a major event to cause reputational damage; it could be a slow death by a thousand negative tweets and online product reviews.
Other risks are more difficult to categorize. They include risks from the environment, such as natural disasters. Difficulties in maintaining a trained staff that has up-to-date skills to operate your business is sometimes called employee risk management. Health and safety risks not covered by OSHA or state agencies fall into this category as do political and economic instability in countries you import from or export to. Vendor or Supplier risks are often ignored. Petrochemical industry is impacted with falling and rising of oil prices. In addition workplace violence is a growing concern, along with the impact of how to deal with the media and legal issues that arise from an event. Terrorism – both national and international have huge impacts across industries.
An organization’s Board and Management Team MUST have clear plans and strategies in place that begin to address the issues that any of these risk factors endanger. In short good leadership is vital.
Next time we will review in detail each type of risk and stratagems to handle them in broad terms.