Managing risk is a pivotal part of business success. But how can you ensure your business isn’t assuming too much risk – some of which can result in potentially serious money troubles? For example what if 60% of your profits come from one client – what would happen if they scaled back business or started extending their payment terms from net 30 to net 60?
Managing risk isn’t something small business owners think about too often, until it jumps up and bites them in the face. But there are some things you can do to anticipate events that may pose a risk to your business and from there develop a fallback strategy to handle any bumps in the road.
“How to Measure Risk in Your Business” is an excellent multi-part series by former Wall Street Journal reporter, Andrew Blackman. In each article, Blackman lays out a very simple way of introducing risk management strategies in the small business environment.
Here are Blackman’s recommendations in the context of managing financial risk:
Identify what your risks are
The best way to do this is to think of the worst-case scenarios that apply to all your financial dealings and touch points.
- What if your best customer changes their payment terms?
- What if you decide to draw on a business line of credit, can you afford the repayments?
- Do you have variable interest rates on any of your debts?
- If you’re a freelancer, what would happen if you got sick and couldn’t work for an extended period of time – how would you pay your bills?
Estimate the likelihood
Okay, you’ve looked at several worst-case scenarios, but what are the chances of these happening? Making this estimation isn’t a science, you’ll need to draw on your own past-experience and gut instinct to come up with a realistic likelihood for each and rank them accordingly. Blackman recommends applying a five-point scale of likelihood, for example:
- Very unlikely
- Quite unlikely
- Medium likelihood (for example, getting sick and not working for days or weeks)
- Quite likely (experiencing an email or IT outage, for example)
- Very likely (for example, if a client has been late paying invoices before, you can rank them as a “5”)
If you’re not sure how to rank various scenarios, Blackman recommends drawing on your network, chances are they’ve experienced things going wrong and can advise on the likelihood of each.
Estimate the impact
Again use a five-point scale to estimate how damaging each of the risks you’ve identified could be –minimal, low, medium, high or devastating. “The best way of thinking about impact is in terms of how much money you would lose,” says Blackman. Combine the impact score with the likelihood score from above.
Create a Risk Scorecard
Now that you know your risks and have ranked them according to scores (likelihood and impact), create a simple scorecard that multiplies the two numbers together to give an overall risk score. You can view a sample scorecard on Blackman’s tutorial on tutsplus.com.
Your scorecard will help provide a visual of the highest and lowest financial risk factors that your business is facing. Remember this is all guesswork, but quantifying your risk in this way can help you develop a plan for dealing with each. Whether it’s looking for ways to diversify your client base and steer away from that high-risk late paying client or bolstering your savings so that you can ride out a period of illness.
Many of these principles can also help you gauge risk across other areas of your business including operations, brand management, etc. Check out Andrew Blackman’s complete series on Managing Risk in Your Business for more insights.