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The Importance of Risk Management – Part 1

The Importance of Risk Management – Part 1

Companies face many different types of risk. Those that can deal with these risks are generally better placed to stay successful. In fact, Ernst and Young found that companies with greater risk management maturity had better financial performance than their peers.

When assessing risk, companies must have both an awareness of the risks they face as well as access to the tools and technology to help them evaluate and mitigate it. In this article, we’ll look at the different risk factors businesses face and how Red Flag Alert can help.

What Risks Do Businesses Face?

The exact number of categories of risk is up for debate. Additionally, many of the categories will blend into others. Poor strategic risk assessments, for example, will likely lead to financial issues. And companies with poor operational risk management may be more likely to fail compliance tests.

Nonetheless, when deciding on a risk management strategy, you should consider each of the following: 

Financial Risk

Cash flow is a major risk to businesses. If a business doesn’t have the money available to pay its debts as they fall due, it can get into serious distress – even if it is in other respects healthy.

One issue that can lead to cash flow problems is clients being unable to pay for work you have completed or products you have sold.

This could be because they are having cash flow problems of their own, or because they have entered administration. Either way, not receiving payments owed can lead to cash flow problems.

The level of risk increases depending on the percentage of your turnover generated by a single client. If you deal with a lot of small companies, it may not be too impactful if one can’t pay. If one company provides 60% of your revenue, however, it will likely be a significant problem if it fails.

This is one of the reasons why so many businesses struggled to deal with the collapse of Carillion. The size of the outsourcing company meant many SMEs were reliant on it for business.

Another financial issue is debt. Businesses may have a plan to deal with a certain interest rate, but sudden increases could have a huge negative impact on companies working with a tight margin. A business will struggle to survive if it is unable to stay profitable due to debt payments.

The list of financial risks goes on: a business needs to be aware of the risks specific to its industry and track them closely.

Strategic Risk

Strategic risk is a common reason for business failures. It will often affect new businesses that have failed to consider all aspects of their go-to-market plan. However, it can also hurt existing successful companies that fail to adjust to a changing environment or take a wrong turn.

The threat of new competitors is a common strategic risk. If a competitor has access to new technology that allows it to make a better or cheaper product, it can have a devastating effect on existing companies. Think about Netflix destroying Blockbuster.

Larger corporations entering the market can also be a major issue, especially if they can sustain losses, have access to better resources, or they can take advantage of economies of scale to produce a product cheaper. Ironically, this is a problem Netflix is now facing from the likes of Disney, Amazon, Apple, and Google.

While companies should make changes to deal with the above risks, doing so can be a risk in itself.

For example, a company may plan to buy a competitor to cement its place in the market and warn off other new entrants. However, if it fails to research the target company properly, and the acquisition isn’t successful, it can put a strain on the finances of the original business.

Compliance and Legal Risk

It is hard to build robust compliance systems: a challenge made more difficult due to evolving rules and regulations.

One example was the recent implementation of GDPR. This regulation introduced stringent requirements on how companies deal with customer data – as well as the potential for larger fines on those who fall foul of regulations.

Recent fines levied on British Airways and the Marriott Hotel Group – around £183m and £99m respectively – show that the regulatory bodies are serious about the introduction of these fines.

Another evolving area of law is Anti-Money Laundering.

As well as compliance with regulations, there is also the risk that companies could face challenges from a legal dispute.

Economic Factors

Every business is affected by the wider economic environment – some businesses are more exposed than others, and mitigating these risks is challenging.

Exchange rate fluctuations, for example, can negatively affect companies that buy or sell products abroad.

A manufacturing company based in the UK buying raw materials from China in pounds will see costs increase if the pound weakens against the yuan; this will eat into profits or cause the manufacturer to raise prices, potentially making its product less competitive.

Of course, exchange rate fluctuations aren’t always negative. In the above example, a UK company selling to China might suddenly find that its product is more competitively priced.

Consumer spending, interest rates and government fiscal strategy can all impact on the success of a business. 

Operational and Process Risk

Not all risk comes from outside forces. Operational and process-related risks inside the company are generally more manageable for well-organised businesses.

Operational risks can come from all kinds of sources. A hard drive failing and taking with it data crucial to the survival of your business is one such risk. Another could be a machine in a manufacturing plant breaking and requiring costly repairs.

It is possible to put in place processes to protect yourself from risk. Backing up data to the ‘cloud’ on a daily basis and putting in place frequent checks to test the health of machinery could significantly reduce the effect of the above two issues.

This brings in another type of risk, however – the failure of processes. If the people in charge of backing up data or testing machines haven’t been doing their job properly, they will expose the company to risk.

Putting in Place Solid Risk Assessment Policies Can Help You Avoid Risk

Risk assessment policies can be used to help make businesses decisions. Businesses can use such policies to define which risks are acceptable, and where further due diligence would need to be performed before decisions are made. Essentially they outline how much risk a company is willing to accept.

These guidelines then need to be accepted throughout the company. Employees need to know which decisions are acceptable and which require further due diligence. Having a risk assessment policy in place can help train employees to apply these standards.

When first implementing these strategies, businesses should frequently review the process to ensure their effectiveness. This could begin with quarterly reviews, moving to a biannual or annual basis as the strategies are fine-tuned and documents improved as issues are found.

Red Flag Alert can help businesses build good risk assessment procedures, providing several solutions designed to address many of the above issues. We’re going to take a look at how Red Flag Alert delivers exceptional risk management in Part 2.

To find out more about how Red Flag Alert can help your business improve its risk management processes, get in touch with Richard West at richard.west@redflagalert.com or 0344 412 6699.

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