There are many reasons why businesses fail to thrive long-term.
Often, though, the main cause of a business’s failure has something to do with poor money management. This might include a lack of cash flow, poor accounting processes, or an underdeveloped (or non-existent) risk management plan.
Does your business have a risk management plan in place? If not, now is the time to create one.
Read on to learn everything you need to know about the importance of financial risk management.
What Is financial risk management?
Risk management is a type of methodology. Its purpose is to help businesses avoid and mitigate adverse consequences that may come from market threats and uncertainties.
Basically, a good risk management plan will help you to avoid losing money when an unexpected event occurs and affects your business.
For example, you might need to have a succession plan in place so that, if a key stakeholder cannot fulfill their responsibilities, the entire business doesn’t crumble.
Why is it important?
There are many reasons why a good risk management plan is essential to a business’s long-term success. The following are some of the primary reasons why you need a risk management plan:
Maintain operation consistency and efficiency
When you start creating a risk management plan, you learn about issues that are keeping your business from running in the most consistent and efficient way possible. Once you’re aware of these issues, you can correct them to ensure your business stays on track.
Increase customer satisfaction
If your business is running in a consistent and efficient way, you’ll be able to offer the best prices and produce the best products for your customers. This, in turn, will help to increase customer satisfaction and foster brand loyalty, both of which are great for long-term business success.
Boost your bottom line
When you have happy customers and efficient business processes, you’re likely going to see a boost to your bottom line, too. Keeping everyone happy and making sure the business runs smoothly are essential if you want to become and remain profitable.
Protect company resources
Having a risk management plan in place helps you avoid having to waste a lot of time and money trying to fix problems when they arise. You’ll know what to do and how to respond to these issues to keep them from becoming serious and expensive problems.
Types of risk
A good risk management plan can do your startup a lot of good. Before you can create a good plan, though, you need to understand the different types of risk.
The following are some specific types that you’ll need to protect yourself from:
This type of risk refers to changing conditions in a specific marketplace. For example, the increase in the number of people shopping online is a market risk that has created a lot of challenges for traditional brick-and-mortar retailers.
Companies that have a good risk management plan and have been able to adapt to this change in shopping habits have fared much better than those that have lagged behind.
This is a type of risk that you incur when you extend credit to customers. It also refers to your own credit risk when you use credit to make purchases from suppliers.
In both cases, there’s the possibility of defaulting on payments, which would leave you or your suppliers to assume the cost.
Liquidity risk refers to both asset liquidity and operational funding liquidity.
Asset liquidity is the relative ease with which you can convert your assets into cash. Operational funding liquidity refers to your daily cash flow.
Good cash flow management is essential to help you mitigate both types of liquidity risk.
Operational risk encompasses all the risks that arise from day-to-day business operations. This might include things like lawsuits, fraud risk, business model risk, and personnel issues.
Engaging in good business practices and having a solid business plan from the beginning can help startups to avoid these issues.
Risk management strategies
Now, you’re ready to start creating a risk management plan. Here are some key strategies to utilize when you begin this process:
Choose the right business entity
When you’re first getting started, it’s important to choose the right business entity.
If you use an LLC or corporation, you’ll have personal liability protection. That way, if something goes seriously wrong, you at least won’t have to worry about losing your personal assets.
Invest in insurance
Insurance is essential for every startup. There are several different types of insurance policies you’ll want to purchase, including the following:
- A business owners policy (or BOP)
- Professional liability coverage
- a business interruption policy
- Workers’ compensation insurance (if you have employees)
If you have employees, you’ll also want to purchase employer practices liability insurance (or EPLI).
Put everything in writing
Get in the habit of putting everything in writing and having attorneys draw up or review your contracts now. This will save you from a lot of potential problems later on.
Prepare for disaster
Have a plan in place should a disaster occur.
This could be a natural disaster or a technological disaster, such as a security breach. Have a plan for how you’ll weather the storm (literal or figurative) and get back on your feet.
Engage in good business practices
Finally, be sure to engage in good business practices, too.
This includes thorough vetting before bringing on employees, promoting safety to minimize accidents, and complying with federal, state, and local laws.
These practices will save you from having to research more info on risk management in the future.
Get more financial advice today
As you can see, it’s very important to look into financial risk management as a business owner.
Remember, if you make it a priority now, you’ll be less likely to find yourself in difficult financial situations in the future.
Do you want to learn more about managing finances while running a business? If so, don’t forget to check out the Money section of our site today.
You’ll find all kinds of helpful resources there that will teach you more about good business money management skills.