Identifying and managing common business risks
Learn to recognize and stay ahead of potential risks for your business.
December 6, 2022 9 min read
Business risks are inherent in any operation. While it's impossible to eliminate all of them, identifying the potential risks for your business may help you minimize them. Understanding your business’s risks should also help you develop solutions and plans for when they occur, allowing you to act quickly to protect your business.
What is business risk?
Business risks are internal or external factors that may impede your company's financial goals. They may include political or regulatory changes, natural disasters, loss of reputation or consumer demand, private or public health emergencies and economic downturns.
If you're unprepared, any of these factors may cause you to restructure your business, halt or delay operations, lose investors or consumers, jeopardize professional partnerships or face other challenges.
Types of business risk and how to manage them
Types of business risk include but are not limited to the following:
Understanding each type should help you identify their potential for affecting your business, which is the first step in mitigating them. To help you assess and manage your business risks, we’ve compiled a list of each risk type and tips for mitigation.
Financial risk refers to threats to a company's cash flow, assets and liabilities. It jeopardizes a business's profits and financial sustainability. There are 4 common financial risks a business may encounter:
- Credit risk refers to extending credit to clients who may become unable to pay their balance, resulting in lost earnings.
- Default risk refers to taking on business debt or credit that your company may not be able to repay.
- Liquidity risk occurs when you don’t have enough assets that can be quickly liquidated to pay off short-term or immediate debt.
- Currency risk, or exchange-rate risk, happens when business transactions, agreements or partnerships involve foreign currency. Exchange rates may fluctuate unexpectedly, causing you to owe more or earn less than anticipated.
Managing financial risks
You can keep funds flowing when financial uncertainties occur. Some best practices include:
- Reduce your operational costs and debts to maximize disposable earnings and maintain a healthy cash flow.
- Diversify and expand your clientele for sustainable growth.
- Choose low-interest options when applying for loans or lines of credit.
- Minimize foreign currency risks by conducting business in your country’s native currency whenever possible.
Investments and assets that you can sell or capital your business can access in case of financial predicaments may help minimize the effects of economic or business downturns.
Compliance and legal risks
Good business practices include abiding by all federal and state laws, industry regulations and contractual agreements with suppliers, consumers, lenders and other entities. Violating any of these, even unknowingly, may result in legal consequences, like fines and damaged standing with consumers or investors. Examples of laws and regulations that require compliance include:
- Workplace laws, which mandate fair pay and working conditions for employees
- Consumer protection laws for financial institutions, which help ensure consumers are treated fairly
- HIPAA regulations for health care industries, which protect patients’ medical privacy
- Industry regulations, which exist to ensure worker, consumer and public health safety
- Business contracts, which may outline terms of service and are usually legally binding
Managing compliance and legal risks
Compliance management is an important way to reduce organizational risk. While specific requirements may vary depending on the business structure, your corporate values are the foundation for strong compliance management.
- If your business is a corporation, you should consider holding initial and annual director and shareholder meetings, record those meetings’ minutes, adopt and maintain bylaws, issue stock to shareholders and record stock transfers.
- If your business is an LLC, you should consider holding annual meetings, create and maintain a current operating agreement, issue membership shares and keep records of membership interest transfers.
- If your business is neither of those, you should still document important business decisions, record minutes for important meetings and keep detailed records of key transactions or business reports.
Filing requirements vary by state and business structure, but in general, you should file annual or biennial statements, initial reports, franchise taxes and articles of amendment. Some of these may have fees. Federal filing requirements typically only include federal taxes (like income and employer taxes) and, if you have 50 or more employees, health coverage reporting for the Affordable Care Act. Any licenses, permits or certificates your business needs should be maintained and kept up to date.
Most businesses, particularly corporations, should also employ legal professionals to monitor and maintain legal, regulatory and contractual compliance. They may help diffuse situations proactively and help your business navigate legal situations smoothly. Businesses of all sizes also often benefit from HR staff and compliance technology, such as payroll software.
Operational risk arises when daily operations—or something that interferes with them—threaten profits. Examples include:
- Natural disasters, like tornadoes, that halt or impede daily operations are considered operational risks.
- Internal errors, such as a website giving a 5% discount instead of a 10% discount, may be considered operational risks.
- External business fraud, like theft by a third party, can be an operational risk.
Managing operational risks
There are ways you can control variables that will help you better manage operational risks. Start by regularly reviewing your procedures and operations to identify and mitigate potential risks. For example:
- Ensure your business spaces are up to building codes and regulations so they can better withstand natural disasters.
- Develop a contingency plan for when disaster strikes, such as having work-from-home capabilities, to reduce the impact to your business.
- Offer comprehensive risk management employee training and implement internal review processes, like website alerts to detect errors early or random quality assurance checks on customer service communications, to minimize internal risks.
Reputational risks occur when a company's public image is threatened. These threats may be direct (due to a business's actions), indirect (due to employees' actions) or peripheral (due to business partners' actions). A poor reputation may discourage consumers, investors and professional partners from engaging with the brand. Reputational risks may include:
- Nationwide recalls or negative reviews for products (direct)
- Staff being exposed for illegal or immoral actions outside of work (indirect)
- A notable business partner garnering negative attention (peripheral)
Managing reputational risks
Implementing quality control at all levels of your business may help minimize reputational risks like recalls, negative reviews and poor consumer experiences. A good place to start is to monitor online reviews regarding your company and partners to identify concerns and be proactive in taking accountability and addressing them. You may also consider hiring a public relations specialist to manage your company's image and reputation. They should help you cultivate the representation you want and get ahead of or navigate potential reputational risks.
Strategic risks arise when business strategies are inherently risky, faulty or not executed properly. Strategies that are inherently risky aren't always undesirable, as some can pay off, but ones that are faulty or aren't properly carried out may impede the success of a business. Strategy risks may include:
- A major marketing initiative that fails to overcome the competition
- Investments in research and development that don’t yield the desired results
- A miscommunication impacting the success of a business strategy
Managing strategic risks
To manage strategic risks, develop a business plan that includes an expert review of projects and action items. Check in with all levels of leadership regularly to ensure strategies are being executed to plan. Weigh the chance and benefits of success when considering risky investments, and have contingency plans to mitigate the effects of an unsuccessful investment or strategy.
Competitive risks refer to losing a competitive foothold in an industry or market. They're also sometimes known as comfort risks because businesses that become comfortable in their standing may be less motivated to stay competitive.
Examples include outdated product lines or lack of company response to industry changes, both of which may allow competitors to gain more of the market share.
Managing competitive risks
Key to managing competitive risks is the ability to remain flexible to accommodate change. Business leaders who understand this regularly monitor industry trends and changes by subscribing to leading newsletters and resources for their industry. They use that research to strengthen business strategy, investing in promising new innovations or capitalizing on shifts in demand. Follow their lead and solicit feedback from clients and consumers to improve your products, services and consumer experiences, and invest in market research to identify product or service gaps your business may be able to fill. Pay attention to your main competitors, and offer in-demand products, services or features that they don't.
Human risks are those that can affect a business due to internal team members' actions or circumstances. Some are unavoidable, such as sudden illness. Human risks may be minimized with proper precautions, engaging employees and support. Examples of human risks include:
- A regional leader experiencing a medical emergency that requires several weeks off for recovery, which affects that region's productivity
- An important company figure experiencing a substance abuse disorder that impacts their judgment and performance
- A new employee inappropriately using company funds
Managing human risks
Encouraging your team members to prioritize their health and providing resources that help them be healthy may minimize the medical emergencies that can impact your business (along with potentially providing other benefits, like happier and more productive employees). Other measures that may help minimize human risks and their consequences include:
- Professionally screening new employees
- Having adequate staffing and managerial backups in place to minimize the impact if someone falls ill
- Enabling financial security features to minimize risk, like transaction limits on employee credit cards, double-signature requirements for company checks and thorough review of company transactions by high-level staff
Physical risks refer to damage to physical assets, such as a business's building or equipment. Compensating for the damage may impact profits, and incidents may halt operations. Injury to employees or bystanders may also impact the business. Physical risk scenarios include:
- Production equipment catches fire
- A nearby fire hydrant malfunctions and floods the office space
- An accident occurs that damages a company vehicle, which was parked nearby
Managing physical risks
There are ways you can help control the variables of physical risk to your business. Some tactics include:
- Ensure your business property has necessary safety features, including sprinkler systems, illuminated exits, fire extinguishers, security systems and evacuation plans
- Maintain all equipment and vehicles to minimize malfunctions, and make sure your building complies with safety regulations and codes
- Have emergency plans in place in case of fire, flood or workplace accident, and have staff review these plans each year to enable fast response and minimize injury or damage
Planning for business risks can help prevent and mitigate them
It may not be feasible to eliminate all business risks, but there are ways to control risk variables, manage uncertainties and avoid a business crisis. Identifying potential risks, actively working to prevent them and developing plans to minimize their impact when they occur is often the best strategy to protect your business.