Risk Management

By Entrepreneur Staff


Risk Management Definition:

Decisions to accept exposure or reduce vulnerabilities by either mitigating the risks or applying cost effective controls

When you're just getting started and attempting to evaluate the risks involved with the particular business you want to launch, it's important to understand that every business venture--regardless of economic climate, market conditions, products, personnel and capitalization--has risks. Once you assess those risks, you can begin taking steps to reduce them. Start by taking these actions:

Research similar businesses. Look at their locations, advertising, staff requirements, hours they're open and their equipment. This preliminary analysis of your competition is a gold mine of important information.

Evaluate current market trends. What seemed like a hot idea over the past few months might have been a fad. Find last year's phone book and call several new businesses. Are they still around? (If you live in a small community or want to expand your research, your local telephone company or local library may have phone books from other cities.)

Know your strengths and preferences. Is this type of business a good fit? Does it capitalize on your strengths? To compensate for areas that you have little or no expertise in, can you fill in the gaps either with staff members, partners, or consultants?

Examine your family budget. How big a financial cushion do you have, in case your financial projections show that you won't be able to draw a paycheck for the first year? What other income can you reasonably expect while you're in the start-up phase? It always helps if your spouse or partner has a full-time job with health-insurance coverage and other benefits through his or her employer. Remember that you're not in this alone and realize that your family is there for you, to share the benefits as well as the risks. To ensure their support, make sure they understand exactly what you're doing, and why.

Know how changes in the economy will affect your business. What would happen to a business in your industry if inflation rose by two points? How has your type of business performed in various economic conditions? If the business is a seasonal one, will patrons of your business travel or spend less?

Write a business plan. Your business plan will help you shape your business, determine your financing needs, evaluate your competition, and figure out marketing strategies. It enables you to foresee problems and make a plan to avoid them-in short, becoming a valuable management tool in running your business.

Once you've launched your business, recognizing the risks in all areas of your business--management, marketing, contracts, personnel, and the particular ramifications of your product or service on customers and the market--is the first step in effective risk management. Follow these steps before talking to an insurance representative about the type of coverage you need for your business:

  • Make a list of the risks your business faces.

  • Evaluate your liabilities from your customers' point of view.

  • Chart the customers' path as they come into contact with your shop--across the sidewalk, through the door, under the ceiling fan, up to your counter, and so on.

After identifying the risks inherent to your business, estimate the probability of financial loss in various situations that could go wrong. Develop a worst-case scenario and put a price tag on it: shop damage, employee injuries or harm to a customer because of your product or service. Next, determine the most economical way to handle the possible losses, considering the following avenues:

Assumption means assuming the risk and the accompanying financial burdens. Sometimes absorbing a risk is prudent. If you're a one-person graphic-design business, no employees are going to be injured on the job. Nor are you likely to be sued for personal injury if clients infrequently visit your office. However, if you own a bakery that employs 30 people, you'd best not assume any risks pertaining to employees getting injured on the job or a customer tossing their cookies because of eating one of yours.

Avoidance means removing the cause of risk. If a caustic material is making employees hesitant and fearful, replace it with a nonhazardous substance. The cost is small compared to what you'd pay if an accident happened. An organized company safety program that implements suggestions from employees and insurance safety representatives can also help eliminate potentially dangerous situations in your business.

Loss reduction is the transfer of the risk to another party altogether. When your own delivery service has problems--tardiness, damaged goods, mechanical breakdowns, and employee hassles-consider contracting a delivery service to take all the headaches away. Similar circumstances include contracting for maintenance, electrical, plumbing, carpentry, bookkeeping, landscaping, and security. Such actions are a form of insurance because you have shifted the risk and responsibility to another party for a negotiated fee.

However, shifting the risk and responsibility doesn't necessarily shift the liability. When the new landscaping crew improperly installs a sprinkler head causing water damage to the inside of a nearby Jaguar, you can hold the landscaping firm liable, but the man who falls into the cactus plant by the front office and injures himself will hold you liable for planting it there. Know what your potential liabilities are and make sure you're covered.

Self-insurance entails setting aside a specified amount of money into a reserve fund each year to cover any losses incurred. The owner holds the cash in this reserve fund, rather than paying premiums to an insurance company. In practice, this method is risky for small firms that could experience a large loss. If the reserve fund is not large enough to cover that loss, the company will be sunk. A growing business with several geographically diverse units is more suited for self-insurance, as are big nonprofit organizations like school systems.

These methods can be used to offset some of risks a business faces. Some areas of risk, however, require the transfer of that risk through insurance, to make sure your business is protected and not overly exposed.

Sound insurance planning requires attention on all fronts. The usual, plain-vanilla insurance packages need to be complemented by additional special coverages relevant to your business. Cover your largest loss exposure first: the lives and health of you and your employees, the most valuable assets your company has.

See also "Insurance."

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