Risk is everywhere when you’re an entrepreneur; you encounter it at the very beginning of your journey when you’re debating over whether or not to set up your own business. This involves a lot more risk for some than others, yet it’s still a leap of faith – to step into the unknown without knowing with absolute certainty that your venture is going to succeed and make a healthy profit. Under the right circumstances, however, taking risks can reap great rewards; it was Mark Zuckerberg, the founder of Facebook, who famously said: “In a world that’s changing really quickly, the only strategy that is guaranteed to fail is not taking risks.”
What are the different types of business risk?
Setting up your own business is just the first hurdle, after that there are many more risks that you will encounter and have to make a decision on.
Business risk, according to Investopedia, is the “possibility that a company will have lower than anticipated profits or experience a loss rather than taking a profit”. Here are some of the common risks that companies face:
- Strategic risk – for example, new competitors coming on to the market, merger and acquisition activity and industry changes.
- Compliance risk – for example, changes in the law. You may also need to comply with new rules and regulations if you decide to export.
- Operational risk – risks that occur within your own business, for example a machinery failure, server outage or theft or fraud.
- Financial risk – for example, non-payment by a customer which could lead to a written-off debt. Poor planning of financial projections and fluctuating foreign currency exchange rates can also contribute to financial risk.
- Reputational risk – anything that can ruin your brand’s image, for example a product recall, court case or negative story in the press.
It’s important to stress that not all of these are within your control; you can’t stop new legislation from coming into force, or new competitors from entering the market. However, you can have a plan in place on how you’re going to deal with these unexpected events before they happen. We’ll come on to that next.
Why is risk management so important?
Let’s look at an example. A negative story about your business has just leaked to the press – you have two choices: you can ignore the article and hope that no-one takes notice or you can address the situation through effective crisis communication management. This may include providing the media with a quote, so that your side of the story is heard.
If the article is particularly unfavourable – and you don’t do anything about it – it may end up causing harm to your brand’s reputation. First you’ll notice a level of distrust among your customers, some of them might stop buying from you or using your services all together, and prospective customers will be put off from the get go. This drop in sales will eventually affect your cash flow, and cash flow issues are one of the main reasons why businesses fail. An extreme example perhaps, but not unrealistic.
This is where risk management comes in – it’s far easier to identify potential problems and to come up with viable solutions for them, should they ever happen. Here are four areas which make up an effective risk management strategy:
- Identify – look at every aspect of your business and write down any possible risks. It may be good to start with the risk types covered earlier in this article: strategic, compliance, operational, financial and reputational.
- Review – every couple of months you should review the risks you identified in step one – how likely is it that they will happen now? Some may not be relevant anymore and there may be new risks that you can add to the list.
- Plan – work out how you are going to mitigate or handle each risk, should it present itself. In the example above, it may be that you could monitor the news more frequently, or decide on who will be the dedicated spokesperson for your company.
- React – put measures in place, where necessary. It may be that you can combat late payment by adding your bank details to your invoices, for ease of the customer.
What about financial risk management in specific?
Last year, we asked members of the Company Check Community to tell us about their experience of financial risk and how they manage it day-to-day in their businesses. What we found was quite surprising – 68% of respondents have had to deal with late payments and 53% have had to write off bad debts in the past. What’s more, 63% of businesses said they do not insure themselves against financial risk.
The Federation of Small Businesses (FSB) also conducted its own research into the matter and found that one in four SMEs go bankrupt if the average sum outstanding grows to £50,000 (the average sum outstanding in 2015 was £31,901).
One way to mitigate your chances of developing cash flow issues is to monitor the finances of the companies you do business with, which is where Company Check comes in. So what should you be looking at when you download a Company Check business report?
- Years trading – check out how many years the company’s been trading for – it’s not the be all and end all but it’s good indication.
- Compare assets to liabilities – if the latter is higher that the former for one year or more, that could indicate that there are large bank loans outstanding, high wage costs or mismanagement.
- Check out the business’ directors – are they easy to find, and do any of them have closed or resigned directorships, or have they been involved in businesses which have since dissolved? This can happen for many different reasons (administration, wind up orders or voluntary liquidation) but it’s important to know.