RISK MANAGEMENT - CAN YOU AFFORD TO IGNORE IT?

Risk analysis and management is of vital importance by itself, but it can also have added benefits.

The process involves identifying, assessing and mitigating threats that could potentially affect your business, perhaps even destroy all the value that has been created. Extreme events like Covid-19 and the 2008 financial crisis are extreme examples of this, but there may also be less severe matters keeping you awake at night.

As business owners you took the step of starting up in the first place and invested time and money setting up and growing the business. Once established, any business that generates profit is valuable and like any other asset it needs to be protected.

A review of risk helps with this protection and is a great way for your team to brainstorm factors surrounding the business, leading to problem solving and innovative ideas.

An example of a common problem in small companies is customer and supplier concentration. To resolve this risk will require the whole company, especially Sales and Marketing, as clearly it will be better to grow and diversify rather than have sales fall off from losing a key client. Adding additional suppliers can lead to cost savings and extending the range of goods and services sold. Clearly reducing risks might require growth. So it is crucial to steer clear from unnecessary exposure and mitigate against those that are not totally under your control.

Once identified, some dangers are easy to remove or reduce. It is also important to know where the main ones are. Even if they can’t be removed, it is useful to know what level of risk you are taking.

Risks firstly need to be identified.

They obviously differ from business to business but the type of categories one might expect are as follows:

  • Strategic decisions
  • Operational
  • Financial
  • Contractual
  • Regulatory/Compliance
  • Reputational
  • External factors
  • Customer / Supplier concentration.
  • System problems
  • Health & Safety
  • Flood / Fire
  • Loss of key employee

Within these categories, each function in the business can be assessed and those that could have a negative affect are recognised. Ask yourself “could this happen” and “what if it did”?

Risk assessment

Once the risks within each category are identified they can be assessed for their likelihood and the impact they could have on the business. A helpful method here is to allocate scores to the level of likelihood and impact, so as to establish those risks that require the most attention and management. As an example, five levels of impact could be used ranging from unimportant to calamitous and the same number of criteria for likelihood used, spanning infrequent to almost definite. If these are each allocated scores of 1 to 5 respectively from best case to worst case and the scores multiplied, then the highest risk item will have a score of 25.

The next step is to analyse what existing mitigations are in place and adjust the scores accordingly. This helps to see where there is good risk management in place already, but more importantly where there are gaps in your exposure to threats. How can you circumvent, decrease or transfer these risks? Are there some you just have to accept? The revised score, after allowing for existing mitigations, clearly defines what remedial and planning work is required. Which ones should you focus on? Are there some low cost easy wins? Of course, something may happen requiring immediate action such as a loss of a key customer, legal or reputational problem etc.

In allocating the scores, discussions can be held around the quantitative and qualitative justifications for them; part of the brainstorming platform mentioned above.

A plan is then put in place to detail strategies for dealing with the exposures. It is important to allocate time and resources to preparing your plan in order to reduce the likelihood of an incident affecting your business and this plan should be kept track of and updated regularly as part of the management processes. An assessment in the build up to insurance renewal is an especially good time as it helps to identify insurable risks.

When it comes to selling your business, a prospective buyer will be assessing risks in the business and this will affect their valuation. Addressing these in advance makes your business stronger and also more attractive to a potential buyer.

About the author

This was written by Brian Kilcullen, a Commercial FD with over 30 years’ experience in business.

Brian is a member of FD4, which is a network of experienced commercial Finance Directors that are passionate about adding value to Companies. They are engaged Part Time (on an hourly or daily basis) to do the work of a full time Finance Director, but at a fraction of the cost. They specialise in driving extra profit, controlling risk & cash, enabling growth and business planning - see more at www.fd4.co.uk