How big are your risks? What is the outcome? What can I do about it?
Simply treating all risks that you may be exposed to in your business “as equal” in your business plan doesn’t really help you manage them effectively, nor will it help an investor understand them. Further, whilst you probably know intuitively that some are more likely than others to occur, an investor who doesn’t really know you, will be left thinking you haven’t really thought them through.
I had a lot of exposure to risk in my investment banking career, and have subsequently carried this discipline to business. Of course, the risk metrics used in the investment banking world has been proven to be flawed post GFC, but the framework of assessing risk is a good one.
That is – for any given risk, a bank assesses what is the probability of it happening and what is the likely impact, and what are the mitigating actions to minimize the risk and or address the outcomes if it does happen. I don’t think Lehmans were very good at assessing risk to put it lightly but the framework was there I am sure.
It is pretty straightforward when all we are talking about is numbers – and when you have huge statistical ddatabases at your fingertips:
eg $100,000 invested in a company is a $100,000 at risk.
A) What’s the worst case scenario? $100,000 loss.
B) What is the probability of this happening? Using statistics, the bank would consider that, on average, it should be expected that a loss will occur x% of the time [averages proved to be a very expensive metric to rely upon in the run up to the GFC – as it was not an average event].
C) What can we do to reduce the impact of risk?
a. not take one [and not get a return] or
b.hedge.
Hedging is generally the preferred option.
I am not suggesting that it is necessary to develop the level of sophistication that a bank might have in their assessment of risk, but we can apply similar principals that will add enormous clarity on what the risks are in your business. It is not necessary to get too hung up on the exact score you give something your gut will tell you.
In business and ideally in your business plan, your assessment of risk can follow a similar framework as follows:
- State the risk – in wordss is fine
- Apply a score between 1-10 to show the probability of occurrence
- Apply a score between 1-10 to show the impact of such an occurrence
- Take the product of the probability and impact scores
- Rank them
- Add in a mitigating action to minimise the impact
- Are there any actions that can be taken to minimse the actual risk of it occurring?
Here are some examples of how risk in your business might be presented – you wouldn’t have all these entries in your assessment only one for the risk of death of the owner for example – the ones listed are only for illustration purposes:
Assessment of risk is A LOT more subjective in business in general than lending money. But attempting some sort of objective assessment like the above will go along way to demonstrate you have a handle on the overall risk of being in business.
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