Last editedJun 20213 min read
The benefits of risk management for businesses cannot be overstated. Every business owner will know how many companies go out of business and the variety of reasons why. Creating an effective risk management framework within which to operate is the best way to avoid joining them.
There will always be the potential for absolute disaster to strike due to unforeseen circumstances, but a sound risk management strategy minimises the number of risky circumstances that go unforeseen.
Let’s look at the different types of risk management strategy and how they can be implemented.
Types of risk management
There are four main types of risk management framework, and each has its pros and cons that suit particular business models and their inherent risks. There are instances where three of the risk management plans could be used within one organisation, although one or two will usually suffice for small to medium-sized businesses.
Risk avoidance
It is possible to run certain businesses with a complete risk avoidance strategy. This means avoiding any business activities that contain a risk factor. Of course, this is simply impossible for many business models, as there will be inherent risk in at least some areas of their operations. For such companies to forego the potential returns of the inherent risks would defeat the purpose of going into business in the first place.
Risk minimisation
A risk minimisation strategy involves analysing the risk elements of a company’s operations – wholly or partly – and implementing small adjustments that reduce their potential impact. This business risk management plan will likely also reduce the potential returns, so a fine balance must be found to ensure the rewards are still worth the risk after the risk has been reduced.
Applying this risk management solution to certain endeavours rather than to the entire business can be rewarding, as it allows certain risk-inherent departments to operate without fear of damaging the whole business.
Risk transfer
Sharing the risk between multiple parties is another risk management plan that can reduce the burden of each risk for each party. For instance, a decision that is ultimately a gamble can be agreed upon by multiple executives, with this sharing of authority adding a sanity check to each speculative decision.
Another risk transfer is an insurance policy, which technically creates two risks as you are paying for something that might not happen. However, the insurance policy ensures that the worst case scenario is not too damaging, even if it reduces the positive rewards.
Risk ownership
Risk ownership is about calculating the potential loss and accepting it as a part of the business plan. Obviously this is not a good strategy for big risks that can severely damage a company, but it can often be the best policy for much smaller risks that can easily be absorbed by the firm.
There are plenty of business models where multiple small risks the company will accept losses on are covered by the gains of the risks that do work out. The “speculate to accumulate” type of business is based entirely on risk, suggesting this should be the most in danger, but such businesses usually have intense risk management strategies that inform their decisions and allow them to take several small risks at a time.
Defining the risk management process
A risk management plan involves a few relatively simple steps that can be applied across the board. These steps include:
Identifying all risks
Assessing the risks
Evaluating each risk
Acting on the data
Risk identification
The first step is to identify any risks associated with the business operations both internal and external. These may range from trades and investments to reactions to social media campaigns and employee behaviour when interacting with customers.
Risk assessment
Once the risks have been identified, they can be assessed to see what effects they may have on the business. These include how hard the risk will affect the bottom line or brand reputation. Some risks might not have a devastating financial impact, but will affect how other parts of the business operate. Each risk should be thoroughly analysed so they can then be evaluated.
Risk evaluation
After assessing the risks and all their potential effects on the business, you can rank them according to several factors. First you can rank them according to how likely each risk is to occur, then rank them according to the severity of the outcome. Other rankings can be compiled according to how each risk affects other areas of the business.
Risk management action
Next, you can implement the most suitable risk management strategy as outlined in the first section. Remember – it is not just about reducing the probability of a bad outcome, but also about maximising the probability of a positive one.
We Can Help
If you’re interested in finding out more about the risk management process, or any other aspect of your business and its finances, then get in touch with our financial experts. Discover how GoCardless can help you with ad hoc payments or recurring payments.
