Why is an effective risk management plan important for your business?
In a small business, it is unlikely that you can avoid all the financial, physical, or material risks associated with a given project or venture. No matter how thoroughly you plan, you will never be able to anticipate everything that you, your workforce, and your business partners will encounter in a foreseeable future. Moreover, it is observed that when a risk becomes a problem, it is usually the consequence of a series of errors. And, these could have been prevented if the key concepts of effective risk management planning were followed.
Creating a comprehensive risk management plan for your organisation is all about ensuring that your business can withstand almost any form of unanticipated scenario or surprise sent its way. By taking the effort to identify potential risks and developing a plan for dealing with, combatting and limiting the effects of these risks, you can place your company in a better position to succeed. But, creating an effective risk management strategy for your company is no easy feat. It's a complicated procedure that demands business owners to consider every critical component of their operation. It's a never-ending procedure and continues as long as your company remains operational. However, if done correctly, it will pay significant dividends and allow business owners to focus on growing their companies. It allows them to take more calculated risks without having to worry about the "unforeseen circumstances" that may potentially cripple their companies.
This detailed article discusses a step-by-step approach to create an effective risk management plan, describes strategies for recognising and prioritising threats, and defines essential concepts and checkpoints.
Steps to create an Effective Risk Management Plan for Your Business
Step 1: Define and Identify business risks
Defining your business risks is the first step in creating a comprehensive risk management plan. A business risk is a scenario, incident or event that has the potential to harm your company. A natural calamity is a common and simple example of such a risk. If your area is hit by a massive storm, there is a good chance that your business will be severely damaged. In another example, if you have not taken any steps to protect your company's computer systems from cybercriminals, your crucial business data is definitely at risk of getting into the wrong hands.
Obviously, the forms of risks that exist differ widely from one business to the next. It depends on various aspects and qualities that may characterise a business, such as industry, size, location, and so on. This is why, you need to conduct a thorough examination of the risks that your business encounters. This allows you to not only have a solid sense of the potential problems you may encounter in the future but also to evaluate how important these risks are. This will also enable you to comprehend what you will need to do to mitigate them.
The five types of risk listed below constitute the categories into which the bulk of common business risks are expected to fall-
- Compliance risk
Compliance risk is linked to different statutory laws and regulations that your business must follow in order to lawfully continue to deliver its products or services. You may think that once a company is compliant, it always stays that way. But, it's not completely true. Laws and regulations, like every other element of business, are always evolving and changing. In order to ensure compliance, your company must be aware of these developments. As your business grows, there is a high possibility that you will need to start complying with new laws and regulations that you didn't have to worry about earlier.
- Strategic risk
All successful businesses begin with meticulous planning on all fronts. Creating a risk management strategy is undoubtedly one aspect of this critical process. However, no strategy is infallible, and in today's continuously changing business environment, even great plans can rapidly turn into not-so-good ideas. That is essentially what strategic risk implies.
However, no strategy is infallible, and in today's continuously changing business environment, even great plans can rapidly turn into not-so-good plans. That is essentially what strategic risk implies. Strategic risk denotes the possibility that your company's business strategies will cease to produce results and become increasingly less effective at any time. As a result, your organization will undoubtedly struggle to meet its strategic objectives.
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Many factors can have an impact on the strategic risks that your business encounters. It might be the entry of a new competitor who is wooing and winning over your customers. It is possible that your company has failed to adapt to technological advancements. It could also be an increase in the cost of creating your product or service that your organization is unable to offset through sales. To reduce strategic risk, your company must be flexible and nimble and capable of making strategic changes as necessary.
- Financial Risk
While every other category of risk we are discussing here has a financial component, financial risk points to something more particular. Financial risk is associated with your company's expenses and revenue, as well as how they interact with and affect the business. For example, the possibility that your expenses will suddenly skyrocket and overwhelm your revenue is unquestionably a financial risk. If your company has taken a substantial amount of loans and is heavily in debt, your financial risk will be increased. This is because even a slight increase in the interest rates of your loan can cost you a significant sum of money.
- Operational risk
The operational risks of your company are related to the daily events and operations of your business and whether these activities are handled correctly. An operational risk could include your computer systems or cash registers, but it could also involve your employees.
For example, let us assume your company has been the victim of a cybercrime. It may have caused your servers to fail, preventing you from processing orders and collecting payments. It shows that the risk of someone external to your organisation compromising your systems or causing damage to your business always looms large. Such a breach can have a detrimental impact on your day-to-day operations.
Employee-related operational risk may also affect your company. Assume the employee accountable for your employee benefits makes a mistake, causing your organisation to lose money and could be sued by a former employee too. That is an example of an operational risk related to your employees.
- Reputational risk
It is perhaps the most self-explanatory risk. Any damage to your company's reputation has the potential to be catastrophic. A company's reputation is how it is regarded by everyone in its ecosystem. This may include employees, partners, customers, investors and everyone else associated with the company in any manner.
A sexual harassment or wrongful termination claim, for example, might have a significant negative impact on your company. These types of events may demoralise your staff. These may also encourage clients, partners, or investors to quit working with you and associating themselves with your business. They may think continuing with you may cause their reputation and credibility to plunge in a similar manner.
Professional liability issues can also jeopardise the reputation of your business. For example, if your legal firm is sued by a client for legal malpractice and the allegation grows into a high-profile lawsuit, even if you win the case, your reputation would suffer.
Product malfunctions are another example of an issue that could damage your company's reputation. Anything that has the potential to influence the general public to have a negative or less positive perception of your company is a possible source of reputational risk.
Step 2: Analyse and Evaluate the risks
Once you have identified all your risks, it's time to analyse and evaluate them to figure out which ones are the most dangerous. While evaluating your risks, two factors must be considered: how likely they are and how significant an impact they could possibly have on your business. To make the analysis procedure easier, categorise all risks based on apparent similarities around core causes. Risk can be assessed using both qualitative and quantitative methods. A mixed-method approach gives the most comprehensive framework for your risk management plan.
- Qualitative Risk Assessment
A risk narrative must be constructed before risk management policies can be developed and implemented. Qualitative risk analysis adds to that narrative by describing specific risks in terms of hazards, severity, probability and overall risk. The findings of your qualitative risk analysis can then be used in a Contingency Analysis (also called, sensitivity analysis), which attempts to draw actionable items to perform in the event of specific risk events.
- Quantitative Risk Assessment ( QRA)
A QRA's objective is to translate qualitative ideas into measurable metrics that may be factored into the budget and schedule for the project. The quantifiable value allocated to a specific risk is subsequently applied as a contingency value to the cost of the project or time estimate.
While evaluating the risks, you start by deciding whether a particular risk is urgent or costly enough to require preventive action, or if it is a risk you can afford to take. A risk assessment matrix is a standard tool used at this level of risk management planning. Such a matrix is created in four steps:
- Determine the risk universe.
- Establish risk criteria.
- Assess the risks.
- Prioritise the risks.
Once you have evaluated your risks and have a rough knowledge of which risks are possibly most detrimental to your business, you can begin the process of determining how to deal with and manage these risks.
Step 3: Treat the risks
After you have completed your risk assessment matrix, you ought to have got a clear understanding of the high, medium and low-priority risks that your business confronts. Making a decision on how to prepare your business to deal with these risks is what this part of developing a risk management plan involves.
In most circumstances, one of these four solutions can be used to do so:
If you believe your business would benefit substantially from a new location but are worried about the risks associated, one strategy you may take is to reduce the level of the risk. You can accomplish this by either lowering the possible negative impact of the plan or taking actions to reduce the likelihood of a negative outcome. For example, you could find a less expensive strategy to expand your business. Opening a food truck instead of a full-fledged new restaurant establishment, or increasing your delivery locations, could be low-risk options to grow your business with less risk.
Because it can be used in almost every form of risk, reduction is arguably the most frequently employed method for dealing with business risks.
Some risks are so dangerous that you wouldn't like to touch them at all. The wisest course of action is to avoid them entirely. The problem with such risks is that they are quite tempting, as they can be really profitable. Consider opening another location for your restaurant. While it has the potential to deliver you huge earnings, your evaluations may indicate that your company may not be fully ready to undertake this next step. If you have evaluated the risk and believe that, in the worst-case situation, launching a new location could financially destroy your business, the wisest plan of action is to avoid this risk.
However, this does not rule out the possibility of opening a new location entirely. Risk management is a continuous discipline, which means you will be revisiting and analysing this concept on a regular basis. It may not be as dangerous a proposition in a few years as it is now.
Most modest risks in business can easily be accepted as a standard. If you have evaluated a risk as minor, the best thing to do is to proceed with the plan, as it is unlikely to have a negative impact on your business. Continuing with our example of the restaurant business, opting to start delivering food may be regarded as an acceptable risk. You can also start slowly by limiting your delivery radius or hiring a third-party delivery provider to handle the job, rather than recruiting your own delivery team.
In this case, your company does not stand to lose much. Even if your move to start delivering food may not be successful, but, there is very little possibility that it will be disastrous for your business. You do not need to spend thousands on market research, hire experienced delivery personnel and purchase and insure new autos to add deliveries. You can do so with little investment and risk, making the risk entirely acceptable.
Finally, let's talk about insurance. Every part of your organisation poses a relatively significant risk. But, do keep in mind that everything critical to success should be protected with insurance. With business insurance, you can transfer a significant portion of your financial risk to your insurer. When you enter an insurance contract, you are paying a premium to shift a specific risk from yourself to a third party. And, because there are numerous risks pertinent to any form of business, there are numerous types of business insurance your company could potentially obtain.
Commercial general liability and property insurance are the most typical insurance plans purchased by companies. General liability insurance protects your organisation from claims filed against it for third-party physical injury or property damage. It should cover defence costs as well as prospective settlements. Property insurance will protect your company if your property is damaged or stolen, or if any of your company's storage facilities, equipment, or signage gets damaged or stolen.
Here is a breakdown of some popular business insurance plans and the risks they cover your company:
- Directors & Officers Insurance ( D&O Insurance)- D&O Insurance is a policy designed to cover the potential legal liabilities of directors, board members and other employees in a management/supervisory capacity-in case they get indicted over the decisions taken by them to manage the business. This insurance cover protects the personal assets of the directors and officers and compensates them for settlements and legal expenses resulting from such suits and litigations.
- Cyber liability insurance- Cyber liability insurance is a coverage that helps businesses and individuals reduce their financial risk exposure. It does so by covering the costs of the damage and recovery caused by a data breach, a ransomware attack, or a cyber security incident. It also covers the costs of fines for noncompliance, crisis communications, lawsuits, forensics, investigations, customer refunds, and even extortion payments.
- Commercial crime insurance- Commercial crime insurance is a type of insurance that provides coverage for businesses against losses caused by criminal acts such as theft, fraud, and embezzlement. This type of insurance can be purchased by companies to protect against financial losses resulting from criminal activities committed by employees, customers, vendors, or other third parties. With the increasing incidents of cybercrime and internal fraud, commercial crime insurance has become a crucial part of risk management for any business. By having this coverage in place, businesses can improve their risk management practices, protect their assets, and improve their reputation. Moreover, commercial crime insurance can also help you improve the risk management practices in your company. By purchasing such coverage, you can identify potential vulnerabilities in your operations and take steps to mitigate them. This can help you reduce the likelihood of losses occurring in the first place.
- Step 4- Monitor & Review
It is critical to emphasise that risk management is a continuous and cyclical process. You can't just stitch together a risk management plan and expect it to perform as expected. The risks that your company faces evolve as it develops. Even if your company isn't expanding or changing, outside factors can impact the risks to which your company is exposed at any given time.
Once you have created a risk management plan for your company it is important to check in on a regular basis to see how it is performing and whether it is functioning at all. Here are a few methods to do so-
- Meetings and Assessments
At status meetings, risk assessment should always be included on the agenda. Discussions should be held on continuing reassessments of immediate risks and notifying the team of any risks that no longer exists.
- Risk Audits
It is related to examining and documenting the effectiveness of each risk response.
- Analysis of Variance and Trend
To regulate and monitor risk occurrences by comparing planned and actual results, with the help of performance data.
- Root Cause Analysis
Re-evaluate the primary causes of any risk events that happened to discover the failing system, implement protocols, and appropriately categorise the risks when you need to do later on.
Hope the discussion above would help you put together a highly effective risk management plan for your business. Transferring your risks to a third party will provide the greatest assistance to implement the plan effectively. To learn more about business insurance, the types of products your company requires, and how to put together the perfect insurance plan for your company at the right price, you may contact BimaKavach. Here, you can get the best recommendation for any insurance product in just 5 minutes.