Broadly speaking, a business risk can be grouped into three large categories – Operational Business Risk, Financial Business Risk, and Governmental Business Risk.
We can all agree that some business ventures are inherently riskier than others. A product-based business focused on a new product in a brand-new category is far riskier than, say, a service-based cleaning company that operates in an established service category. Small business risk comes in many different forms. Some you’ll be able to prepare for, and there are others you can’t.
A PESTEL analysis allows a business to consider macro-environmental conditions, while Porter’s Five Forces allows a business to consider the micro-environmental forces that can alter the risk profile of a business.
That said, it is always a good idea to review your risk exposure from time to time and develop a plan to deal with anything that comes up before you are forced to deal with them during a crisis.
Operational Business Risk Defined
Operational business risks are failures related to day-to-day operations that can impede a company’s ability to earn revenue. Often operational business risks are the result of insufficient or failed processes. An example of a few operational business risks might be:
- A clogged toilet in your restaurant necessitates that the business closes until it gets it fixed.
- Your web hosting company goes offline for several hours making access to your company’s e-commerce site unavailable, thereby causing you to lose sales.
- The flu epidemic hits your business, resulting in high absenteeism and causes the company to miss a deadline.
Operational business risk can be broken down into six types of risks.
Strategic risk is where a business has risk associated with taking on or changing the businesses strategy direction. Strategic risk involves the owner weighing the pros and cons of taking the business in a new direction. Here are three common examples of strategic risk.
- You have a successful business in one part of town. You are thinking about opening a second location across town to grow your business. Will this new location add to your already successful business or cause you to fail?
- You have outgrown your current physical space requirements. You are considering signing a new lease on a much larger space which may provide growth options for you in the future. Will moving to a much larger space increase your operational capacity or will the increased rent cause more financial risk
- You spot a product that you think will sell well in your store. You agree to buy the product in bulk, lowering your per-product cost and providing you with more margin. Will the product sell as fast as you projected or will you have to heavily discount it just to get a portion of your invested money back?
Reputation risk is where the company’s reputation is tarnished as a result of an incident perceived as being dishonest, disrespectful or incompetent. Reputation risk is generally associated with a serious loss of trust or confidence in your business.
Here are three common examples of reputation risk.
- An employee has their laptop stolen that contains sensitive client information.
- A customer has a bad experience with your business. Rather than addressing the customer’s issue, the owner defends the company’s actions and the customer leaves a negative review about your establishment that goes viral.
- An employee is overheard speaking ill about a client. An employee of the client firm takes out their phone and records the discussion. A few days later, the company and the owner are hit with a lawsuit claiming slander.
Quality risk is where you fail to meet the quality goals of your products, services and/or business practices. You don’t need to be the manufacturer of the goods or the person delivering a service to be affected by quality risk.
If you sell a product that does not meet the customers; quality expectations, the customer will hold the retail business accountable for any injury or damages.
Moreover, your business may use a subcontractor whose potion of the project fails to meet the customers’ expectations. The customer will not hold the subcontractor accountable, but instead hold your business responsible.
Resource risk is where a lack of resources, including both human and financial, can cause a business to fail to meet its objectives.
For example, your customer says that your video production company did a great job on a recent promotional video. Now they what you to handle all of their video production needs. Can you find enough videographers and video editors to support this new work? Do you have the financial resources available to purchase the necessary new equipment to support the increased workload?
As a business grows it often needs more employees. With more employees comes greater risk. Studies have shown that employee turnover can cost a company 150% of the employee’s annual salary to replace. Additionally, when a company has non-owner employees, there are a huge number of employment laws that the business needs to be aware of and follow. These laws can be both federal and state level. Most states also require that you buy workers’ compensation insurance to protect employees against workplace injuries.
Seasonal risk is where a company’s revenue is concentrated in a single season. For example, a landscaper is very busy in the summer months, whereas the winters are lean. Similarly, a ski rental business is very busy in the winter but the summers are very lean.
Structure risk is where the location of the business, be it a home office or in a commercial property, can suffer damage. Here are three common types of structure risks.
Infrastructure – Is the premise in a high crime neighborhood? Is it secure?
Natural Disaster – Is the premise in a floodplain, hurricane or earthquake zone?
Fire – Is the premise’s construction, for example, wood siding, making it more prone to fire? Could something like a nearby wildfire, and the subsequent effects such as flooding impact business operations?
Contract risk is where the business may be forced to live up to the fine print in a contract or fail to be able to hold a vendor of customer accountable.
Contracts can be complicated and are not something that is directly billable. Therefore, contracts are often overlooked by many small business owners. Starting a project just based on a handshake agreement is risky. Verbal contracts, while technically legal, are difficult to enforce and boil down to what he said vs what she said. While verbal contracts are appropriate in some situations, a written contract is definitely more robust and more likely to stand up in court if there are any disputes.
When entering into a contract with a large company, these companies will almost always have you sign their contracts. Failing to read the fine print may put a business at risk.
The bigger the business, the bigger the risk. As a business grows, it is more likely to work with other companies such as a marketing or social media companies. Be sure to read the fine print in all contracts. When in doubt, have your lawyer check it out.
Financial Business Risk Defined
Financial business risk is where external factors can cause a business to lose money. Financial business risk has the potential to produce damaging results for the business. An example of financial business risk is when a customer declares bankruptcy, leaving you unable to pay your bills since you haven’t been paid.
Financial business risk can be broken down into four types of risks.
Credit risk is where individual consumers or businesses to whom you have extended credit fail to pay you. Credit risk is sometimes called accounts receivable risk.
The absence of a payment or delays in payments will strain a company’s financial resources. This results in cash flow issues that have been known to destroy many small businesses.
It is always recommended to run a credit report before you sign any contracts as a way to assess the creditworthiness of the other party. As tempting as it may be to engage with the customer, partner or supplier in a lucrative deal, one that has poor credit is a recipe for financial risks.
Reference USA is a tool offered by many pubic libraries which can provide a basic credit rating of any potential customer, partners, and suppliers for free.
Currency risk is where volatile foreign exchange rates can impact the value of a business transaction and or its assets. Currency risk is sometimes called exchange rate risk.
Many businesses today use off-shore resources or buy or sell goods to and from other countries. When the exchange rate between your country of origin and where you purchase or sell goods and services changes, it introduces currency or exchange rate risk.
Interest Rate Risk
Interest rate risk is where a change in interest rates affects a business’s profitability. Interest rate risk can be self-induced or externally-induced. An example of self-induced interest rate risk is a change in a business’s creditworthiness as a result of late on payments. or when their debt to income ratio changes. An example of an externally-induced interest rate risk is when the Federal Reserve changes its benchmark interest rate.
Inflation risk is where an investment in the business will not be worth as much in the future because of changes in purchasing power. A dollar today has greater purchasing power than the same dollar next year due to inflation. Therefore, investments that have a fixed return over a longer period have a greater inflation risk than ones with a variable return over a shorter period.
Governmental Business Risk Defined
Governmental business risks are where political events and outcomes can impede a businesses’ ability to succeed, or encourage businesses to take certain actions. Governmental business risk can be broken down into three types of risks.
Taxation risk is where new tax laws or new interpretations result in either higher taxes for you or lower taxes for your competitor. Governments are fans of using tax policy to preserve industries or to affect change. For example, your competitor may receive a tax credit because some of their power is generated from solar cells, which gives them a competitive advantage. Conversely, your business might be subject to a carbon tax, making your business less competitive.
Moreover, changes in the way taxes are imposed on a businesses’ profits or upon how capital gains are treated can encourage or discourage many different types of investments.
Filing taxes as a small business owner is more challenging than simply filing individual taxes. The tax cuts and jobs act recently made business tax filings even more complicated. Different tax rules apply depending upon your business entity type. Additionally, there have been changes to deductions. depreciation and expenses that can be claimed. Many new provisions have been added and in some states, the amount that can be written off for state and local taxes has been capped.
The US tax code is full of penalties too. Some common reasons the IRS charges penalties include, underpayment of estimated taxes, failure to pay taxes reported on an informational return, failure to file or missing filing deadlines, and errors due to negligence. Moreover, overlooking deductions can also result in a smaller refund or paying higher taxes. It’s always advisable to seek professional advice with respect to business taxes, and not be self-prepared as a way to prevent falling into tax-traps.
Compliance risk is where you break laws or fail to follow established federal, state, or municipal regulations. In many cases, compliance risk is due to simple oversight or human error and not one of deliberately or wantonly violating laws and regulations. However, compliance issues can cause legal liabilities for a business.
Compliance risk – also called regulatory risk – is not only something to be considered in large companies. One common example of a compliance risk might be that your industry requires an eyewash station for employees. Not having one, or not even knowing that you need one for your industry represents a degree of compliance risk. Another example of compliance risk is a product that does not adhere to properly established safety standards. One compliance risk I have personally witnessed is where a landscaper begins working prior to 8:00 AM and received a noise complaint.
Country risk is where doing business in a country that experiences negative effects associated with political events or with its economy. For example, you may make a product that you sell to another business, who then bundles your product into their product that they sell to China, and is exposed to tariffs in the trade war.
Have you considered your exposure to operational, financial, and governmental business risk lately, and devised a plan to deal with potential problems?