Most people consider setting up a business high risk. Small businesses face a number of risks, but not all of them are necessarily bad. It’s all about planning and managing those risks to make sure a business can survive if things don’t go exactly as planned. That is where a risk assessment matrix comes in.
There is a strong relationship between risk and reward. It is impossible to achieve business gains without taking on at least some risk. The purpose of risk management isn’t to eliminate risk, but to optimize the risk-reward ratio within the bounds of the business owner’s risk tolerance.
Avoiding risk is always a good idea whenever possible. However, some risk is necessary to ensure the survival and growth of any business. Therefore, the business owner must look at ways to mitigate their risk wherever possible. As they say:
Prepare for the worst and hope for the best.
A risk assessment matrix is a tool that is used during the risk assessment process. It defines the level of risk by considering the probability or likelihood of an event against the severity of the consequence to the business if it were to occur. A risk assessment matrix is a visible representation of risks to assist a business in decision making and mitigation.
1. The first step in developing a risk assessment matrix is to make a list of all the operational, financial and governmental business risks.
Operational business risks are failures related to day-to-day operations that can impede a company’s ability to earn revenue. Often operational business risks are the result of insufficient or failed processes.
Operational business risk can be broken down into seven types of risks.
- Strategic Risk is where a business has risk associated with taking on or changing the business’s strategic direction.
- Reputation Risk is where the company’s reputation is tarnished as a result of an incident perceived as being dishonest, disrespectful or incompetent.
- Quality Risk is where you fail to meet the quality goals of your products, services, and/or business practices.
- Resource Risk is where a lack of resources, including both human and financial, can cause a business to fail to meet its objectives.
- Seasonal Risk is where a company’s revenue is concentrated in a single season.
- Structure Risk is where the location of the business, be it a home office or in a commercial property, can suffer damage.
- Contract Risk is where the business may be forced to live up to the fine print in a contract or fail to be able to hold a vendor or customer accountable.
Financial business risk is where external factors can cause a business to lose money. Financial business risk has the potential to produce damaging results for the business.
Financial business risk can be broken down into four types of risks.
- Credit Risk is where individual consumers or businesses to whom you have extended credit fail to pay you.
- Currency Risk is where volatile foreign exchange rates can impact the value of a business transaction and or its assets.
- Interest Rate Risk is where a change in interest rates affects a business’s profitability.
- Inflation Risk is where an investment in the business will not be worth as much in the future because of changes in purchasing power.
Governmental business risks are where political events and outcomes can impede a businesses’ ability to succeed, or encourage businesses to take certain actions.
Governmental business risk can be broken down into three types of risks.
- Taxation Risk is where new tax laws or new interpretations result in either higher taxes for you or lower taxes for your competitor.
- Compliance Risk is where you break laws or fail to follow established federal, state, or municipal regulations.
- Country Risk is where doing business in a country that experiences negative effects associated with political events or with its economy.
2. The next step is to take the list of risks that you developed in the previous step and add the likelihood that the risk may occur to each one. Risk likelihood can be divided into three categories:
- Probable – Very likely to happen
- Possible – Some chance of happening
- Improbable – Small chance of happening
3. Next, look and each risk and determine its impact to the business if it were to happen. Risk impact can be divided into four categories:
0 – Acceptable – little to no effect on the business
1 – Tolerable – effects are felt but do not seriously effect the business
2 – Unacceptable – causes major disruption to the business
3 – Intolerable – business may not recover
4. Based on the likelihood and impact of each risk. place each risk into a Risk Assessment Matrix.
You can download a Small Business Risk Assessment or create your own.
The advantages of using a risk assessment matrix when it comes to risk assessment is that it helps the business to:
- Prioritize risks with their level of severity to the business
- Neutralize the possible consequences by helping to focus mitigation efforts
- Analyze potential risks with minimal effort
- Visually convey potential risks
It’s not easy to assess risks, let alone manage them. It’s important to understand that a risk assessment matrix is only a tool, not a complete solution. Developing a risk assessment matrix involves a lot of subjective assignments, and assigning arbitrary values to risks based on ambiguous information. However, in spite of its shortcomings in terms of total accuracy, it is a great tool to give the business a place to start when it comes to risk management and developing a mitigation strategy.
Do you have a risk assessment matrix for your business?
IF YOU LIKE OUR CONTENT PLEASE SUBSCRIBE AND SHARE IT ON YOUR SOCIAL MEDIA CHANNELS. THANK YOU!