After the few years we've had, many SMEs like you will be wondering if they need to invest more into risk management. Indeed, it seems more pressing than ever to protect your business as much as you possibly can. To do so, you must be prepared for all the different types of business risk - and how you might tackle them if they were to arise.
In this article, we'll be providing your much-needed 101 on Risk Management Strategy, and how you can be prepared for the worst. We'll cover:
The definition of risk management
Why a risk management strategy is beneficial
The types of risk your business might face
4 strategies for risk management
What is risk management?
A risk is any event or threat that prevents a company from achieving its objectives. A risk management plan is a written document that identifies and evaluates risk to a company and outlines steps to be taken to mitigate the risks.
Why is a risk management strategy beneficial?
Risks allow a company to thrive, without risk there is little reward. However, a company must be able to identify, evaluate and mitigate the risks that would be of detrimental impact to their income or objectives.
A proper risk management strategy will not only minimise the impact of risk, but can reduce costs, improve stakeholder confidence and allow a business to appropriately allocate resource.
What types of business risk might I face?
While there can be various types of business risk you need to be aware of, the 4 main risks faced by businesses are:
Financial - A financial risk is caused by poor financial planning, an example of a financial risk is fluctuating exchange rates.
Strategic - A strategic risk is when external or internal factors prevent a business from achieving their strategic goals, an example of a strategic cost is changes to supply costs.
Compliance and Regulatory Risks - A compliance and regulatory risk is the result of external regulations being violated, an example is a privacy breach.
Operational Risks - An operational risk is caused by inadequate or failed internal processes, an example of an operational risk is managerial inefficiencies.
How can I manage risk?
There are 4 main strategies for dealing with all the risks we’ve discussed.
Risk acceptance (also known as risk retention) is a strategy where once a risk has been identified and evaluated, a company or person decide the impact from the risk is manageable. Often the potential loss from this risk does not warrant the time or finances required to mitigate it.
Using risk acceptance as a risk management strategy is usually for low impact or low likelihood risks. Risks associated with laws, regulations, safety or large financial impact will not be managed with risk acceptance. Caution must be taken, as risk acceptance does has the least amount of immediate cost when managing risk, it does have the potential to be the most expensive in the long term.
An example of risk acceptance could be that a handbag manufacturer know there is a 0.5% chance the zip’s they use will be faulty. The manufacturer decide to accept this risk as it is cheaper to refund or replace the customer with a faulty zip, than to change supplier.
Risk transference is a strategy where a business outsource certain operations to a third party, who assume the liabilities. Simply put, the business are transferring the risk away from themselves.
Transferring risk through third parties could be the primary reason for outsourcing, such as purchasing an insurance policy or outsourcing IT security and databases. An example could be a doctor purchasing malpractice insurance, they are contractually shifting the risk from themselves to the insurance provider. Risk transference can also be a secondary benefit to outsourcing operation such as payroll or order fulfilment.
Risk avoidance is a strategy where a business can reduce their level of risk by avoiding taking the risk altogether. While risk avoidance might seem like the obvious choice when it comes to minimising the impact of risks, avoiding risks can result in loosing out on potential gain that accepting risks can bring to a business. Therefore, avoiding a risk completely must be of benefit to the company in the long-term.
An example of risk avoidance is choosing not to use certain hazardous chemicals due to the dangers associated with handling and storing them.
Risk reduction is a strategy where a business will identify a risk and then take steps to reduce the likelihood or severity of the risk or its impacts.
One example of risk reduction would be to budget finances to prevent over-spending. Another example would be to implement emergency plans such as fire drills or emergency supplies in an attempt to prevent the impact of a disaster.
How to access help managing risk?
Unfortunately, when managing risk there isn’t a quick fix or easy answer. Your risk management plan will likely adopt all 4 types of risk management strategies depending on the type and severity of risks you identify to your business. When used together, these risk management strategies can greatly reduce the impacts of risk that you will face everyday as a business.
Tackling risk in business doesn’t need to be stressful if you have the right resources. Our finance experts are experienced in analysing business risk both internally and externally, to create a thorough risk management strategy.
Get in touch with us today if you need the help of a full or part-time CFO/FD to help your business thrive.