“You only have to do a very few things right in your life so long as you don’t do too many things wrong.” - Warren Buffett
This well-known Warren Buffet quote holds true for companies, too. The art is in knowing the difference between the right things and the wrong ones. Business owners must be able to determine which aspects of the business they should spend time on and get right vs. which aspects only require a safety net so you don’t go too far wrong.
At its heart, risk management is about identifying the things that might prevent a business from meeting its goals and about putting processes in place to address them. Today’s economic environment, with higher interest rates than we have seen in years and risk of recession, provides a great time to stop and think about risks.
Here are five questions to start your assessment:
- How are risks currently built into your planning process? The typical areas include traditional insurance assessments, supply chain analysis, and your treasury function. These are the parts of an organization that normally have the language to talk about risks and have formal way to reduce them. Risks are reduced through having multiple sources of key supplies and making sure you have adequate insurance coverage. Economic hedges can be put in place for key prices or rates.
- How can you harness the power of your full team to identify risks that haven’t been considered in the traditional functions? Many businesses link this to the preparation of annual budgets or forecasts. Each function with a stake in the forecast knows their own areas and the relevant market forces unique to your business. They may not all have the language of risk, but they know what keeps them up at night. Keep in mind that there are also operational risks that are addressed by more traditional internal controls over finances.
- How do you assess the potential impact of risks? This is a combination of how likely the risks are to occur and what it will cost if they do. Businesses that have a robust risk process may be able to calculate a percentage probability for each with ease and identify the cost. It can seem overwhelming to those with less practice. One way to start is to sort things into three buckets – those likely to have high impact, low impact, or moderate impact. That way, you can focus on the high impact risks first.
- What is your appetite for risk? This will help ensure you don’t spend too much time chasing risks below your tolerance or overlook some that might be critical. The process of communicating this tolerance for risk might also unlock opportunities that have been assumed to be too risky.
- How can you address risks and what would it cost? To address risks, you can do any of the following:
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- Avoid them. A fashion company may avoid the risk of fleeting trends by sticking with more traditional styles.
- Produce duplicates with various resources. The risk of losing computer records is mitigated by using back-ups or multiple servers.
- Prevent or reduce them with controls and limits. If one product line is very profitable, but subject to supply chain disruption, it could be limited to a smaller portion of the overall business.
- Transfer them through insurance, contracts, or pricing. The risk of changes in pricing key components can be shared with the customers retaining them.
It’s important to consider both the cost and benefit associated with each of the options above.
These five questions make it seem like risk management is a process you go through periodically, but the most successful private companies incorporate it across the organization. Harness the power of your full team in looking for both opportunities and risks. A framework that addresses both will build resilience as you develop experience with considering not just the risks, but how to address them. If you have any questions or would like to discuss this process in more detail, please contact us.
Jennifer Kreischer can be reached at Email or 215.441.4600.
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