November 10, 2020 13 min read

Creating an Effective Risk Management Plan for Your Business

risk management plan cover

When you’re running your own business, the only thing that’s certain is uncertainty. No matter how well you plan and prepare every aspect of your operation, there’s no way for you to anticipate everything you, your employees, and business partners are going to experience over the course of time.

Even if you have the perfect product or service with the perfect fit and the perfect plan for bringing it to market, success is never guaranteed.

How many times have you talked to someone whose business failed due to “unforeseen circumstances?”

Putting together a proper risk management plan for your business is all about making sure that your business is able to survive just about any type of unforeseen circumstances and surprises thrown its way. By taking the time to identify potential risks and putting together a plan for addressing, combating, and mitigating the potential effects of these risks, you are putting your business in a better position to not only survive but succeed.

And while no risk management plan can make your business “disaster-proof,” a good one can certainly increase your chances of long-term prosperity.

Putting together an effective risk management plan for your business is certainly no easy task. It’s a complex process that requires business owners to take every important aspect of their business into consideration. It’s a process that never really ends as long as your business is functional.

However, it’s also a process that, if done properly, will pay significant dividends and allow business owners to focus on growing their companies by enabling them to take more calculated risks in order to spark faster growth without having to worry about the aforementioned “unforeseen circumstances” potentially crippling their company.

defining business risk illustration

Defining Business Risks

The first step in putting together a quality risk management plan for your business is defining your business risks.

So what constitutes a business risk? A business risk is a circumstance, occurrence, or event that can potentially have a negative effect on your business.

A common and easy-to-understand example is a natural disaster. If your area is hit by a hurricane, the risk that your business is going to be destroyed or at least damaged definitely exists. Or if you haven’t put any efforts into protecting your business’s computer systems from cybercriminals, your business data is clearly at risk of falling into the wrong hands.

Obviously, the types of risks that exist vary greatly from business to business depending on the many factors and characteristics that define your company such as industry, size, location, and much more.

identifying risk illustration

Identify Your Risks

The first step you need to take when putting together an effective risk management plan is to take a systematic look at the types of risks that your business faces. This allows you to not only get a good idea of the potential problems you could eventually face, but it also enables you to evaluate how serious these risks are and understand what you are going to need to do in order to mitigate them.

The following five types of risk represent categories that a majority of everyday business risks would most likely be able to fall into.

Strategic Risk

Successful businesses usually all start with exceptional planning on all fronts. Putting together a risk management plan is definitely one facet of this important process.

However, no strategy is foolproof and in today’s constantly changing business climate, even good plans can age poorly and turn into not-so-good plans very quickly. That is what strategic risk basically means.

Strategic risk means that your company’s business strategies can stop yielding results and start becoming less and less effective at any time. This obviously results in your company struggling to reach its strategic goals.

Many things can influence the strategic risks that your company is facing. It could be the entrance of a new competitor into the market that is targeting and winning your customers over. It could be changes in technology that your business has failed to adapt to. Or it can be an increase in the cost of the production of your product or service that your company can’t seem to make up for through sales.

In order to decrease your strategic risk, your business must be adaptable and quick on its feet, ready to make strategic changes when needed.

Compliance Risk

Compliance risk is related to the various laws and regulations, local or federal, that your business must comply with in order to legally continue to provide its products or services.

You would think that once a business is compliant it stays that way, but that isn’t entirely true. Just like every other aspect of the business world, laws and regulations are constantly changing and evolving as well. Your business needs to make sure to be aware of these changes in order to assure compliance.

As your business changes and grows, there’s always a good chance that you will need to start complying with new regulations and laws at some point over the course of your business’s growth that you didn’t have to worry about earlier on in your journey.

For example, if you have opened up a new branch in a different state, there are going to be new regulations that you are going to have to be aware of related to the new state in which you are working, like making sure that your business is meeting all workers compensation requirements for that particular state.

Operational Risk

Your company’s operational risks are related to the everyday events and processes of your company and whether these processes are being handled successfully. An operational risk could be related to your computer systems or your cash registers, but it could also be related to your employees.

Say your business is the victim of a cybercrime that has crashed your servers, resulting in an inability to process orders and collect payments. The risk of someone outside of your company corrupting your systems or doing damage to your business that negatively affects your day-to-day operations is an operational risk that always exists.

What would an employee-related operational risk look like then? Say the person who is in charge of your employee benefits makes an error that leads to your company not only losing money but possibly being sued by a former employee as well. That would be a good example of an employee-related operational risk.

Financial Risk

While, certainly, every category of risk that we have mentioned and will mention has a financial aspect to it, financial risk refers to something more specific.

Financial risk is related to your business expenses and revenue and how they both interact with and affect your business.

For example, the chance that your expenses suddenly increase drastically and outweigh the revenue coming in can definitely be considered a financial risk.

If your business has taken out a significant amount of loans and is in a lot of debt, that would increase your financial risk as well, because if your company has a lot of debt, even a small increase in your loan’s interest rates could cost you a lot of money.

Reputational Risk

Reputational risk is probably the most self-explanatory. Any damage to the reputation of your business can be potentially crippling. A business’s reputation is the way in which the company is perceived by everyone within its ecosystem; that means customers, employees, partners, investors, and anyone else affiliated with the company in any way.

For example, a sexual harassment or wrongful termination claim against your company could have a very negative effect on your company at all levels. These types of things could demoralize your workforce and influence customers, partners, or investors to stop cooperating with you and associating themselves with your company because doing so could potentially cause their credibility and reputation to plummet in a similar fashion.

Professional liability issues can also lead to reputational risks. For example, if your law firm is sued by a client for legal malpractice and the claim turns into a high-profile lawsuit, that’s something that would represent a reputational risk even if you end up winning the case.

Product malfunctions are another good example of issues that could affect your business’s reputation. Anything that can potentially cause the general public to have a negative, or less positive, opinion of your business represents a reputational risk.

evaluate risk illustration

Evaluate Your Risks

Once you have identified all of your risks, it’s time to evaluate them in order to determine which risks are more dangerous than others.

There are two things that need to be taken into consideration when evaluating your risks; how probable they are and how great of an impact they could potentially have on your business.

One good way of mapping out your risk evaluation process is by putting together a chart in order to analyze each risk and give it a risk score. For each risk, evaluate and rank the likelihood of it occurring from 1-5 and do the same for the possible impact of the risk. Add those two numbers to come up with a risk score. Obviously, the higher the number, the greater the risk.

Once you’ve evaluated your risks and you have a general understanding of which risks are potentially most disruptive to your business, you can then start the process of deciding how you are going to deal with your business risks and manage them accordingly.

dealing with risk illustration

Determine How to Deal with Your Risks

Once you have completed the evaluation and prioritization of your main risks based on the likelihood of them occurring and the potential impact of each, it’s time to decide how you’re going to deal with these risks.

This part of the process of putting together a risk management plan entails making a decision on how you’re going to prepare your business to deal with these risks.

In most cases, one of these four strategies can be implemented on just about any business risk you could potentially face:

Avoidance

Some risks are so potentially serious that you wouldn’t want to touch them with a ten-foot pole. In the case of these most extreme risks, the best thing to do is to eliminate them by completely avoiding them.

The thing about these risks is that they are often very tempting because they can also be incredibly rewarding. Take, for example, opening up a second location for your restaurant. While it could potentially bring you huge profits and double the worth of your business, your evaluations are telling you that your business might not be completely ready to take this next step.

If you’ve evaluated the risk and you believe that there’s a chance that, in the worst-case scenario, opening a new location that ends up doing poorly could destroy your business financially, then the best course of action is to avoid that risk.

However, that doesn’t mean that you’re going to forget about opening a new location entirely. Risk management is an ongoing practice, meaning that you will be regularly revisiting this idea and evaluating it. In several years’ time, it might no longer be as risky of a proposition as it is right now.

Reduction

If you believe that your restaurant would greatly benefit from a new location and you don’t want to abandon the idea entirely, one approach you can take is trying to reduce the level of risk that is associated with the idea.

You can do this by either minimizing the potential negative impact of the plan or taking steps to make the negative outcome less likely.

For example, you could find a cheaper way to expand the business. Opening up a food truck instead of a full-blown new restaurant location or expanding your delivery locations could be ways to expand your business with a reduced level of risk.

Reduction is probably the most commonly used strategy for dealing with business risks because it can be applied to just about any type of risk. It allows you to go forward with plans that might have seemed too risky by introducing measures that have made the plan less so.

Acceptance

Most minor risks can simply be accepted as a regular occurrence in business. If you’ve evaluated the risk as a minor one, the best course of action is to just go ahead with the plan, considering that it doesn’t have the potential to affect your business too negatively.

To continue the example of a restaurant, deciding to finally start delivering food might be considered an acceptable risk. You can even start slow by keeping the delivery radius small or hiring a third-party delivery service to take care of the job for a fee instead of hiring your own delivery staff.

In this example, your business does not have much to lose. Sure, your decision to start delivering food might not end up being profitable, but even if it’s not, there’s a very small chance that it’s going to be catastrophic for your business in any way.

You don’t have to pay thousands of dollars for market research and hire five experienced delivery people and buy and insure new automobiles in order to try out adding deliveries to your restaurant’s offer. You can do so with very little investment and risk, which makes the risk completely acceptable.

Transference

Finally, it’s time to talk about insurance. Every aspect of your business that presents a fairly high risk but, at the same time, is absolutely crucial to the success of your business should be handled with the help of insurance.

With business insurance, you are able to transfer a good portion of the financial risk to a third party, your insurer. When you sign a contract with an insurance company, you are paying a fee to transfer a certain risk from yourself to another party.

And since there is a myriad of risks that are relevant to any type of business, there are many different types of business insurance that your business could potentially purchase.

The most basic insurance policies that businesses most commonly buy are commercial general liability and property insurance. General liability protects your business against claims filed against your company that are related to third-party bodily injury or property damage and should be able to cover defense costs and possible settlements. Property insurance will protect your business in the event that your property is damaged or any equipment, storage facilities, or signage your business owns is damaged or stolen.

Both can be bundled into a Business Owners Policy (BOP), which gives you these two crucial coverages (along with business interruption insurance) for a lower price than it would cost to buy them separately.

Here’s a run-down of some other popular business insurance policies and the risks that they protect your business against:

  • Commercial Auto Insurance: Protects you, your employees, and any other hired drivers against financial responsibility in the case of a work-related car accident involving injury to people or property.
  • Workers Compensation Insurance: Mandatory in just about every U.S. state, workers compensation covers medical expenses, death benefits, lost wages, and rehabilitation for injured employees. It will also cover the legal costs of potential claims filed by injured employees.
  • Professional Liability Insurance: No matter what services or products your business offers, clients can decide that they are unhappy with the way they were delivered and sue you. Professional liability will protect you from lawsuits related to errors and omissions, negligence, and other common business mistakes that are regularly made. There are even specific insurance products that have been created to deal with the specific professional liability that specific industries face, such as tech errors & omissions for tech startups and legal malpractice liability insurance for law firms, for example.
  • Employment Practices Liability Insurance: Also know as EPLI, this insurance policy provides coverage for claims made by employees alleging discrimination (based on sex, gender, race, age, disability, religion), wrongful termination, sexual harassment, and other employment-related issues.
  • Cyber Liability Insurance: One of the most important coverages thanks to the importance of the Internet in today’s business world, cyber liability enables businesses to transfer the costs involved with recovery from a cyberattack, such as a data breach or social engineering attack.
  • Directors & Officers Insurance: Management liability is another important risk that many companies of all sizes deal within today’s business landscape and one that can be mitigated with the right insurance policies. D&O insurance protects the assets of your board of directors from lawsuits related to misuses of company funds, misrepresentations of company assets, breach of fiduciary duty, non-compliance, and more.
  • Commercial Crime Insurance: A good commercial crime policy will protect your business from losses due to crime-related issues such as petty theft, fraud, and burglary committed by both your employees and outside entities.

It’s clear that every one of these four major strategies for dealing with business risk has advantages and disadvantages. That’s why the evaluation process is so important to your risk management plan. It can steer you towards the best option available to you for dealing with each individual business risk.

No matter which strategy you decided to go with, however, it’s important that you are reevaluating the strategy on a regular basis and measuring the effectiveness of the risk management plan that you’ve created, making changes and tweaks where and when needed.

risk management plan illustration

Monitor the Effectiveness of Your Risk Management Plan

It’s important to stress that risk management is an ongoing and cyclical process. You can’t simply put a risk management plan together and expect it to be enough. As your business grows and changes over time, so do the risks that it faces.

And even if your business isn’t changing or growing, there are outside factors that can influence the risks that your business is being exposed to at any point in time.

Once you’ve put together a risk management plan for your business that you’re happy with, the next step is to periodically check to see how it’s doing and whether it’s working.

This step of the process, which is one that repeats periodically, entails going back to the charts and scorecards that you created when evaluating your risks in your initial risk management plan and revisiting them while focusing on two things in particular:

  • How your risks have evolved over time.
  •  How effective your chosen strategies for dealing with them have been.

By reevaluating your risks and your strategies for combating them on a regular basis, you’re able to expand and evolve your strategy and cover your business risks in a more holistic manner while constantly gauging the effectiveness of your risk management plan in order to ongoingly improve and tweak it.

As far as strategies go, transferring your risks to a third party is the one strategy that you’re going to need the most help with in order to implement it as effectively as possible, both in terms of cost and getting the right amount of coverage for your business risks.

To learn more about business insurance, what types of policies your business needs, and how to put together the proper insurance program for your company for the right price, don’t hesitate to reach out to one of our experienced brokers at any time.

Related Articles

What is Contract Negligence?

What is Contract Negligence?

6 min read

Let’s take a look at how contract negligence is defined in order to understand what types of business insurance can protect businesses from such issues.

Read More
What Does Subrogation Mean in Business Insurance?

What Does Subrogation Mean in Business Insurance?

4 min read

If you see the term being used in the business insurance world, subrogation means that your insurer is stepping in for you and assuming your legal right in order to pursue a third party for an insurance claim.

Read More