Business decisions are frequently made by assessing the probability of something going wrong and the consequences if it does. With each choice, there is risk involved, and identifying what that potential risk could help businesses prepare for the unexpected.
Developing an optimized strategy for identifying and analyzing the factors that affect business processes can help increase revenue, prepare for worst-case scenarios, and control hazardous liabilities in the workplace.
Read ahead to learn about how to identify the different types of internal and external business risks, how to manage them, and why conducting a risk analysis is beneficial.
What is a Business Risk Analysis?
A company's exposure to a situation where the outcome may either be beneficial or harmful to its financial health is a business risk. A business risk analysis is a strategy that identifies and analyzes the risk factors that have the potential to cause harm. Managing risk effectively can help mitigate financial loss and improve decision-making processes.
Types of Business Risks
Risks can either arise out of internal or external circumstances. Internal risks occur within the organization during normal business operations, while external risks involve events that emerge from outside the business structure.
Internal risks are easier to manage because they are typically within the company's control. Examples of these potentially harmful liabilities include-
- Financial risks
- Marketing risks
- Operational risks
- Personnel management risks
External risks may necessitate a reactive approach, as they are not within one's control. Outside factors that may affect business processes are-
- Economic changes
- New competitors
- Natural disasters/Pandemic
- Federal and local regulations
- Market changes
- Consumer demand changes
How to Conduct & Use Risk Assessment
Because internal and external factors vary depending on the industry, there is no right way to assess risk. However, there are some general guidelines to follow, including-
It is important to first identify and analyze the type of risk causing the problem and consider the ways it may affect the company. Businesses should also consider whether the risk is worth taking on, as it may help meet key performance metrics and improve business processes. The type of risk can depend on the location, size, and industry of the business.
Weighing Cost to Benefit
A system should be created to measure the cost to benefit ratio of each risk to develop a better understanding of the threat's impact. One way of doing this is to take the best estimate of the probability of an event occurring and multiply it by the amount that it will cost to fix it.
Risk Value = Probability of Event x Cost of Event
For instance, there has been a raw material shortage in fragrance compositions that may affect a vendor's ability to ship them to a small cosmetics manufacturer. If the likelihood of a shortage in fragrance compositions is .05% and the cost to find those compositions from another vendor is $30,000, then the risk value would be $1500.00. Because the likelihood of risk value is relatively low, it is probably better for the company to continue ordering from the current vendor.
Create a Management Strategy
Individuals who will manage and track the potential risks should be appointed. These individuals need to create a set of procedures and contingency plans for risk management.
Next, there should be controls, or solutions put in place to help mitigate the effects of the risk. Knowing how significant the risk is, the likelihood of it occurring, and whether the company can survive it will help determine which controls to put in place.
Review Risk Analysis
Periodically, the risk management processes and procedures should be reviewed to see how threats were handled and whether or not the solutions put in place to mitigate risk were effective. Risk assessment is not a one-time commitment, as there is always a flux of internal and external circumstances that affect business processes.
How to Manage a Risk
Once the risks have been identified and controls are in place to monitor them, companies can determine how to navigate them. Here are 3 approaches-
1. Avoid the Risk
Some risks should be avoided altogether if the cost to benefit ratio is too high. Risks to avoid include taking a business loan when the funding isn't available, overstaffing, or underpricing services to gain new customers. In each of these circumstances, the possible benefits are far outweighed by the potential negative consequences, and the risk should be avoided entirely.
2. Share the Risk
Sharing the risk and the potential gain with third parties or stakeholders is also an option depending on the circumstances. For instance, partnering with an outside organization in a product development initiative will probably lead to an increase in profits for both parties. It will also help mitigate any potential negative consequences because another organization/group of people is partly responsible.
3. Accept the Risk
Accepting the risk is the most optimal option when the threat cannot be avoided, if the prospective financial loss is less than the cost of insuring against the risk, or if the potential gain is worth taking the risk.
Preventative Impact for Risk Acceptance
If the business decides to accept the risk, there are 3 options to temper its impact-
1. Small-Scale Acton
This involves rolling out the high-risk activity on a controlled, small scale. Experiments can be utilized to see where problems arise and calculate how to respond before undergoing the activity on a larger scale. For instance, a company may want to install an instant messaging system to make it easier for employees to communicate with one another. However, they may also be worried that employees will spend too much time chatting on the system instead of working, leading to a decrease in productivity. The company could take a small-scale action by implementing the employee messaging system in one office location to see if it has a negative or positive effect on employee communication and operational efficiency. This is less of a business risk than switching every office over to the system at once.
2. Preventative Action
Preventative action includes taking the necessary steps to decrease the odds of a high-risk situation from occurring. For example, conducting internal audits, reviewing and updating company documents, performing equipment maintenance, and implementing new training programs for employees will prevent the chance of tax fraud, harassment, workplace injury, and other internal misfortunes.
3. Detective Action
Companies can take detective action by identifying which points in a business process are a threat, then putting in place a set of steps to correct or prevent harm. For instance, a retailer might notice that their nightly shift drawer continues to come up short. The manager could then inform employees that a security camera will be installed to detect potential theft. The retailer has identified a threat/risk (theft) and put in place a camera (set of steps) to prevent it from happening again.