The value of a business depends on many things but especially the quality of earnings and risk. When was the last time you evaluated the risks in your business and do you have an effective risk management policy in place? Adrian Price, from Menzies LLP, looks at the different types of risks and how to manage them.
All businesses face risk and need to manage the potential effects of uncertainty throughout their business operations. The key is to identify which are acceptable and which are manageable. When considering risks, there are two main questions that are always asked what is the likelihood of the risk happening to me and what effect would it have on my business?
Types of risk
The most popular risks are financial and operational. Financial risks include losing a key customer, a bad debt and price rises from suppliers. Operational risks are more to do with the running of your business, that is, what would happen if there was a major power failure in the building, a recruitment issue, supply shortages or more seriously, a fire.
Take for example a Domino Pizza business. The oven does not work and it is 11.30am with lunch looming, do you simply close the shop or do you have a backup plan to provide an emergency catering option and maintain customer goodwill? You could always have a spare oven for such emergencies however, the cost could be prohibitive. The likely failure of an oven may be remote but if you have a 30 minute call-out agreement with a supplier to repair it, the risk is managed.
Alternatively, would you rather have a company with £1 million of sales from a single customer, or 10 customers of £100,000? The first has more risk and therefore potentially less value.
Other risks could include competitors coming into the market, environmental and health and safety issues. Therefore, in franchising, if the franchise system is set up properly and managed well, then it can considerably lower both business and investment risks. The fewer risks there are, the greater the chance of success.
Assessing risk
As a start, do some simple assessments, for example, look at a few key areas of your business and assess their good and poor qualities. Provide a score, such as high, medium and low, which will enable you to produce a risk register and focus on the areas where impact and likelihood are high.
“Risk management is not a one-off exercise and needs to be reviewed regularly”
Ranking in order of seriousness to your business and either accepting the risk or changing the risk profile will prove to be beneficial. From a franchise prospective, one of the key risks might be how likely is the franchisor to renew the franchise agreement or even terminate the agreement?
Nothing beats good research, so do consider all the risks and the ways to reduce or manage the impact on your business. Consider if you can simply insure against risk (bad debt insurance, loss of profits insurance policy and so on) and determine how this may affect your objectives. Alternatively, the cost of justifying a potential risk may be high, that doing nothing makes more business sense.
Managing risk
Managing risks helps a business to focus on identifying what could go wrong and how to deal with them, improving the chances of success and achieving your objectives. The process includes:
- Identifying the risks
- Assessing the chances of them happening
- Understanding how to respond to them
- Producing a system to deal with the consequences
- Continually reviewing your approach and control of the risks
Effective risk management has several benefits including better planning and decision making enabling capital and resources to be managed more efficiently. It also helps a business to prepare a contingency plan of the things that could go wrong and therefore provides a more cost effective way of dealing with them.
Risk management is not a one-off exercise and needs to be reviewed regularly in order to be successful. It provides a good learning curve and will help you to make improvements on how to deal and manage future risks.
In summary, you should consider the following four areas:
1. Knowledge – do you have enough in-depth knowledge to have considered all the risks covering key business drivers?
2. Competences – do you have project management, interpersonal and analytical thinking approach to find solutions to problems?
3. Attitude – do you have a positive approach and an inquisitive mind-set?
4. Behaviour – are you committed to the process and do you encourage others to consider risk, since reducing risk will increase value?
Businesses face many risks and cannot completely eliminate them. They should be addressed regularly which in the long term will help to lessen the effects and deliver enhanced and reliable performance.
For further information of to discuss any of the issues raised in this article, please contact: Adrian Price, Partner
T: 01489 566708 E: aprice@menzies.co.uk
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