THE ADVANTAGES OF RISK MANAGEMENT TO ENTREPRENEUR

Risk Management
Entrepreneur Staff

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.

What would you do if you missed a deadline? What if your subcontractor fails to deliver on
time? What do you do if you cannot come at par with your clients expectations? How will
you minimize your risk, if you havent yet perceived it?

According to an article in the Wall Street Journal,

Most business plans fail to make much impression on potential investors. Most arent even read in full.
Their shortcomings tend to be obvious even in a twopage executive summary, largely because they are
written before enough real work has been done to create a solid foundation.
Entrepreneurs, driven by vision and creativity and impulse, often paint the picture too bold
with broad strokes and fail to focus on the details. With such tendencies, they are not only
bound to ignore potential risks, but may add to the impending problems. Not only are the
entrepreneurs unequipped to manage as the seasons change, but their actions may prove
to be counterproductive. And hence, a poorly conceived Business Plan is enough to lead
the enterprise down the drain.

The Risk Management Process

What are the risks for your business? After you identify them, you will need to know what
impact they can potentially make on your business and what actions are needed to be put
into place to control the damage. Planning for all this ahead of time would simply reduce
your time, effort and capital which you would have otherwise invested to put off the fire.

Risk management is simply understanding and forecasting potential problems that an

enterprise may face in future and finding the best way to mitigate the outcomes of if it. But in
order to put this in action, we first need to understand the classification of the risks involved

How to evaluate a risk?

All the risks mainly have two dimensions attached to them: One, the odds of their
occurrence. Second, the severity of the consequences they leave behind. Once we know
how likely they are to occur and sever they would prove to be, we can decide on the correct
plan of action to deal with them.

Quadrant A: Ignorable Risks

Not a big deal at all. Such odds may strike you maybe once in 10 years and leave you
without doing any significant damage.

Quadrant B: Nuisance Risks

Nuisance simple things going wrong very often but their impacts can be easily managed
without any long-term effect on the organization. There are ample examples of such risks,
and with a little common sense, they can be easily straightened out.

Quadrant C: Insurable Risks

Often insurable, such risks have high severity but are relatively unlikely to occur. Here are a
few common forms of insurances and the risks they cover:

Property & Casualty Insurance can mitigate losses from fire, theft, and natural
disasters.

Key Executive Insurance can mitigate losses from the death or incapacitation of a
management team member.
 Liability Insurance can mitigate lawsuits resulting from product defects or on-site
injuries to visitors.

Errors & Omissions Insurance can mitigate lawsuits from disgruntled customers.
Directors & Officers Insurance can mitigate lawsuits in cases of negligence,
harassment, or discrimination.

Quadrant D: The Company Killers

They keep the meaning of their name well justified. With a high probability of occurrence
and major consequences, these risks can crush the start-ups and the market giants alike.
And there are so many of these, you can never really distil your world off their chance. The
main categories to be considered here are:

Strategic Risks: E.g. Entry of a competition in the market

Compliance Risks: E.g. Implementation of a new standard or regulation

Operational Risks: E.g. Breakdown of a machine or disruption in the supply chain

Financial Risks: E.g. Bad-debts by a borrower or hike in the interest rates of a bank
loan

How to Manage Risks?

Eliminate it, by careful analysis of the business environment and back it up with needful
efforts and finances

Accept it, maybe because the cost of eliminating is questionably too high.

Reduce it, by implementing new policies, safety measures etc.

Transfer it, by resorting to insurance.

Use Precaution! (For business continuity)

By far we have understood that risk management is to identify the chance and severity of
the unfavorable circumstances and to find the correct course of action to mitigate their
effect. This could be as simple as keeping a backup of your mobile phone contacts, in case
you lose your phone.

Such programs with referring to threat assessment and risk management are often called
Business continuity plans. They spell out what to do when something happens. As you can
never really eliminate all risks, these processes will minimize their impact on your business
cycle.

Choose the right Insurance

Insurance shares your burden. Not just that, you can use it as a tool to protect against
losses associated with some risks. Although some costs cannot be insured, in some cases
they are a necessity. However, insurance companies now are getting more and more
particular to see that the risk is being managed.

Long term insurance plans here have tremendous use at a personal as well as at the
business level. From a business owners perspective, they can be given as an executive
benefit or an employee benefit, either way they can fetch up to 100% tax benefit for the
organization and hence, have now become an important aspect of financial planning.

Plan your retirement

Yes, Retirement! Avoid future financial troubles. Entrepreneurs may have a hard time
relating to this idea as planning and saving for retirement is contrary to the mentality of
entrepreneurs. But hey! You cannot keep all your eggs in a single basket. Some attractive
instruments which one can ponder upon are zero-coupon bonds, Cash-balanced Pension
Plans, Individual Retirement Accounts (IRA), business valuation or transfer etc.

Most risk managers, consultants, and actuaries believe that proper management of risk is
the key to the longevity of an enterprise. On the other hand, a poorly conceived business is
bound to stop the train before it leaves the station. Hence, an entrepreneur must take all the
time to make a good business plan.