You’ve worked hard to ensure all boxes are checked for a successful product launch: you have a beautifully designed website, saved enough to cover three months of operating costs, and hired a virtual assistant to handle simple tasks you don’t have time to take on. What could possibly be risky about this business?
No matter the precautions you take, all businesses involve some risk. These may be internal risks from employee errors placing incorrect inventory orders, or external risks from a new competitor selling a lower-priced version of your product. By learning about the types of business risks you could face and how to address them, you can be better prepared with a contingency plan that helps ensure your business’s longevity.
What is business risk?
Business risk is anything that could expose you to financial loss, reputational harm, or failure. To assess business risk, examine all pertinent legal, financial, and operational information relating to your business and take any necessary action to prevent or minimize negative outcomes.
Most business owners design a risk management strategy as part of its business continuity plan, which helps protect your business from disruptions such as flooding of your warehouse after a hurricane or a viral video about a negative customer interaction. The strategy includes identifying risks, assessing them, taking steps to avoid or reduce risks, and, in some cases, accepting risk as part of the normal course of business.
Depending on the particular industry, business owners’ risk management strategies might include having comprehensive insurance coverage, minimizing debt, or retaining lawyers to address legal issues.
What causes business risk?
Business risks come in many forms. Examples of events that could cause business risks are:
- Natural disasters. Flooding, storms, wildfires, and other natural disasters can cause business loss.
- Human error. A production mistake, for example, might result in a recall or warehouse overstock.
- Regulations and laws. Rule changes or failure to comply with regulations or laws could impact business operations or financial performance.
- Uncertain financial or economic conditions. Global or national financial crises may affect business solvency, increase exposure to credit risk, and lower profits and revenue.
- Tariffs and currencies. Changes in tariffs and trade policies, or fluctuating currency exchange rates, can impact risk.
6 types of business risk
There are six major types of business risk that can affect how you do business.
1. Financial risk
Financial risk is any situation or factor that jeopardizes a business’s finances and operations. Depending on the sector and a startup’s capital structure, financial risk could be caused by:
- Too much debt
- High interest rates on loans
- Insufficient cash flow from sales
- Poor investment strategies
2. Strategic risk
Incorrect assumptions about the success of a business’s product or service can lead to strategic risks, which involves your ability to execute key business objectives. Examples include:
- There is little or no market demand for a product or service, like a $100 smart shampoo dispenser or a nail salon for pets.
- A brick-and-mortar shop operates out of a beautiful historic building, but its landmarked designation doesn’t allow for expansion to accommodate business growth.
- A startup is creating an app, but in its pursuit of perfection, another startup builds it first.
3. Operational risk
Operational risks are ones that have an impact on a business’s activities and daily workflow. You may face operational risk if you:
- Don’t consider your supply chain and business logistics needs working together holistically—proper supply chain management can help ensure your products are produced and distributed on time
- Are lacking or have insufficient business insurance, which can leave your business exposed to losses from manufacturing breakdowns, product malfunctions, natural disasters or legal damages, among other issues
- Have inadequate information technology (IT) protocols in place when computer systems fail
- Hire employees that repeat human error due to insufficient training, causing harm to productivity
4. Compliance risk
Compliance risk is either failing to qualify for or obtain the correct permits and licenses to operate in accordance with state or federal regulations or laws. Or, it’s being in noncompliance with industry laws and regulations. If you fail to take compliance risks or regulatory risk seriously, your business could be fined, shuttered, or reputation harmed. Actions that might be considered compliance risks include:
- A factory illegally dumping manufacturing byproducts into a local river to avoid waste treatment costs
- Food companies not adhering to health regulations to prevent consumer illness
- Discrimination against job applicants based on gender, race, nationality, religion, or ethnicity, which is illegal under federal law
5. Reputational risk
Reputational risks include actions, behaviors, or events that hurt public opinion of your business. Examples of things that could put a company’s reputation at risk include:
- Social media postings of conflicts or hostile interactions between customers, business owners, or staff
- Failing to honor a return policy or guarantee, selling defective products, or poor customer service
- Companies that experience a cyberattack or customer data breaches
6. Global risk
International businesses may experience global risk when they don’t follow the laws or respect the customs of the countries in which they operate. If your business is involved in international commerce, you may be exposed to geopolitical events such as wars, border conflicts, and elections that could harm your company’s ability to operate profitably and efficiently. Global risks can include:
- Overseas labor disputes
- Gas price hikes
- Border conflicts
- Fluctuating currency exchange rates
- New or increased sanctions, tariffs, and taxes
7 ways to minimize risk to your business
- Calculate risk
- Stay in compliance
- Review the company’s finances to manage debt
- Buy insurance coverage
- Cultivate a loyal customer base
- Diversify suppliers and vendors
- Hire consultants and experts
There are seven steps you can take to manage your business risk:
1. Calculate risk
The best way for a business owner to measure business risk is to conduct a risk analysis that assesses possible threats or adverse events that could hurt your business. A risk assessment may include making budgeting decisions, analyzing future costs, and estimating future sales.
2. Stay in compliance
Staying in compliance with regulations can help ensure that your business avoids fines and penalties, can continue operating, and wins and retains the trust of customers. Compliance strategies include offering training for employees, consistently monitoring industry regulations, and documenting all compliance efforts.
3. Review the company’s finances to manage debt
Regularly review your company’s financial picture to know when to spend and when to cut costs. Taking this approach can assist in managing debt. More specifically, you can:
- Avoid maxing out business credit cards
- Consider business financing options such as low-interest community development financial institution (CDFI) loans that lend money to small businesses that may be considered risky for conventional banks
- Track and monitor cash flow and expenses regularly
- Keep financial obligations, including making on-time monthly payments toward any debt obligations
- Keep a lean budget and low overhead costs
- Save three to six months of operational costs to minimize liquidity risk
4. Buy insurance coverage
Wildfires, hurricanes, floods, among other natural disasters happen, and equipment like ovens, sewing machines, and refrigerators break. Or, you may lose income due to theft or experience a data security breach of your customer information—there’s insurance options for that, too. To help protect yourself, thoroughly research the types of small-business insurance policies available, and pick the ones that best suit your needs. Together with a business continuity plan, you can be better prepared should a business disruption occur.
5. Cultivate a loyal customer base
- Honoring return policies and money-back guarantees
- Creating loyalty programs
- Addressing any customer complaints or negative online reviews
6. Diversify suppliers and vendors
A diverse group of suppliers and vendors ensures that your business can continue if one suddenly goes out of business or experiences supply chain disruptions.
7. Hire experts
If you don’t have the expertise or time to perform certain specialized tasks, hiring professionals could be the solution to keep your business running smoothly. For example, consider hiring accountants, financial experts, or ecommerce consultants to help with financial and compliance responsibilities and prevention of security risks.
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Business risk FAQ
Is my business liable when I didn’t know it was breaking the law?
Yes, it’s the responsibility of business owners to know all the laws and regulations about trade, labor, the environment, and any other issues.
Is it necessary to monitor and evaluate business risks on an ongoing basis?
Yes, as a business owner you should continually be on the lookout for potential risks and always be in full compliance with all regulations and laws.
What are the consequences of not managing business risk?
The consequences of not addressing business risk and avoiding compliance risks—like poor adherence to manufacturing safety regulations—could result in a workplace injury or fines. The business could be sued, facing costly legal judgments that could even result in insolvency or bankruptcy.