Small business risk management

Published • 16/04/2024 | Updated • 16/04/2024

Management

Small business risk management

Published • 16/04/2024 | Updated • 16/04/2024

Risk management is one of those business phrases that you might automatically associate with the world of multinationals and management consultancies. 

However, risk management is an important consideration for small business owners too. Let’s say you run a small café. Things are going swimmingly from week to week, until one day you find yourself unable to open for business due to a flood, a supply chain failure, or a piece of vital kitchen equipment conking out.

Scenarios like this can and do befall the UK’s millions of entrepreneurs, from those exploring business ideas from home to those running customer-facing enterprises.

This highlights why risk management should be a part of your overall operations management strategies. And that’s why we’ve put together this guide laying out the factors to think about, so your small business will not only survive but thrive.

What is small business risk management?

Financial risk management for small business owners means pinpointing, evaluating and developing strategies for responding to risks your business may face.

Regardless of your structure – sole trader, partnership, or limited company – the importance of risk management for small business can’t be overstated. It helps to safeguard your business assets and allows you to pre-empt and efficiently deal with issues relating to all aspects of business operations, from cash flow to customer retention.

Understanding risks

Small businesses face many risks that can affect their growth and operations. These risks are internal, like financial problems or employee issues, or external, such as changes in the economy or natural disasters.

You can tackle internal risks with good management. External risks, though beyond your control, can be prepared for in order to lessen their impact.

As a small business owner, it’s essential to pay attention to both types of risks and plan accordingly. Identifying specific challenges to your business and preparing for them is also crucial.

For example, a café serving food and drink and an online store selling handmade beauty products might both encounter supply chain problems. However, the café might also need to adapt to new food hygiene regulations, whereas the online store could face issues if customers have bad reactions to their products.

Types of risk

Whether internal or external, risks can affect various parts of your business. From issues relating to your finances to technological changes, understanding these risks can help you to prepare and react appropriately. Let’s explore some of the most common risks you should be aware of.

Financial risks

In a sense, all risk management is financial risk management, since your bottom line is what matters most in business. That said, some risk management strategies specifically focus on the cash flow of your business, encompassing everything from handling the cost of overheads and resources, to processing payments and managing debts.

For example, if you run a retail store selling equipment to other businesses, you may face the internal risk of customers failing to settle their accounts on time, impacting your ability to pay your own bills or buy new stock. Or externally, a slump in the economy might cause customers to cut back on spending, affecting your sales and profitability.

The UK’s cost of living crisis offers a timely example of external financial risk, with two out of five small businesses reporting a drop in sales at the start of 2023.

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Strategic risks

Strategic risks relate to the decisions and plans that shape the direction of your business. 

They include internal factors like not having a thorough understanding of how to do market research for small business, which can lead to significant losses. For example, if you launch a product without understanding the target customer base, you may find little to no demand.

Externally, your business might face strategic risks from shifts in consumer preferences, such as the increasing demand for eco-friendly products. If rival businesses start offering more sustainable options while your products remain unchanged, you could lose market share to your competitors.

Compliance risks

Compliance risks relate to the legal and regulatory frameworks that govern your business operations. Internally, this could mean failing to meet the legal requirements for starting a small business, which could result in penalties or delay your entry into the marketplace.  

Externally, your business might encounter new legislation that impacts how you operate, such as changes in data protection regulations.

The General Data Protection Regulation (GDPR), introduced in 2018, provides a relevant example. This legislation impacts all organisations that process the personal data of EU citizens and residents, regardless of size or industry. Consequently, small businesses had to adjust their data handling processes.

Technological risks

These risks stem from the challenges associated with business tech and its integration into your enterprise.

For example, a retail store using an outdated point-of-sale system may operate in a more sluggish, less cost-effective fashion compared to one using a cutting-edge professional solution which streamlines everything from managing stock to taking payments, such as POS Pro.

Meanwhile, there are external technological risks in the form of hackers and online scammers. Indeed, according to the 2024 Allianz Risk Barometer, disruption due to cyber attacks, malware, data breaches and related malicious activity ranks as the most significant global business risk. That’s why small business cyber security is more important now than ever. Externally, your business could also be impacted if your competitors implement technology which makes them more appealing to potential customers. For instance, if you don’t accept payments from digital wallets, but your rivals do, you might lose customers who prefer the convenience of the latest payment methods.

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Operational risks

These are risks which potentially affect your day-to-day business activities. Internally, problems like equipment failure can pause production, impacting your efficiency and profits.

For example, if a key piece of equipment in your small manufacturing business breaks down, it could halt operations until repairs are made.

Externally, your operations could be vulnerable to disruptions caused by geopolitical events. New legislation, political agreements with other countries, and even armed conflict can impact supply chains for small businesses, thanks to the effect on import tariffs and delivery times.

Human resource risks

Human resource risks are those related to managing and supporting your team. Internal issues like poor employee retention can harm your business, creating knowledge gaps and ramping up training costs.

On the external front, you might face challenges such as a shortage of skilled workers, particularly in specialised areas, which can curb your business’s growth.

The changing job market and competition for talent also poses risks; you may need to improve your employment packages to attract and retain the right candidates.

Environmental risks

Environmental risks involve your business's interaction with nature. Poor internal practices, such as improper waste disposal, can harm your reputation and lead to fines.

For example, a restaurant caught improperly disposing of cooking oil may face penalties and public backlash.

Externally, new regulations can bring changes and costs. For instance, if you have a small manufacturing business, stricter regulations like air quality standards may force you to adopt cleaner but costlier technologies.

Reputational risks

Reputational risks are linked to the public image and customer perception of your business. They can arise from negative reviews, poor customer service, or product failures.

For example, if you own a café, your business could suffer reputational damage if customers experience long wait times.

Alternatively, external risks might come from a well-known social media influencer criticising your business, or ordinary members of the public leaving poor reviews on Google or Tripadvisor, significantly impacting trust and loyalty.

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The positive side of risk

It’s important to remember that not all risk is negative. Incorporating calculated risks can boost your business growth strategies and marketing efforts, helping your small business to stand out.

For example, adopting innovative technology may bring some inherent risks in terms of the potential for breakdown or human error, but could ultimately give your enterprise a competitive edge.

Strategic risk-taking can lead to breakthroughs in product development, market position, and customer engagement. Finding the right balance between what you could gain and what you might lose is a big part of effective risk management for small business success. We’ll talk more about the potential benefits of embracing risk later in this guide.

Risk management processes for small businesses

A structured business risk assessment process allows you to prepare for the unexpected, make informed decisions to drive your business forward, and safeguard its future success.

Identify risks

Your first task is to identify risks. In other words, recognising potential problems that could threaten your business operations, financial performance, or reputation, such as those we discussed in the previous section.

It can be useful to conduct a SWOT analysis for small business, listing the strengths and weaknesses of your business, along with opportunities and threats. This helps you to understand internal risks (weaknesses) and external risks (threats) while recognising strengths and opportunities.

Other strategies might include regular team meetings, gathering feedback from customers, and staying updated with industry trends.

Analyse risks

Once you’ve identified potential risks, the next step is to understand how likely and consequential they are. A risk matrix can be useful here, helping you to rank risks by their probability and how bad they could be for your business.

While the term “risk matrix” sounds pretty elaborate, it’s a straightforward grid with the vertical axis indicating the probability of a risk and the horizontal axis indicating the impact of a risk.

Typically, a risk matrix has at least three choices on each axis. For example, the probability axis might be labelled:

  • Rare 

  • Possible

  • Almost certain

The impact axis might be labelled:

  • Insignificant

  • Significant

  • Catastrophic

A more detailed 5x5 matrix might include additional options such as “Rare” and “Almost Certain” for probability and “Insignificant” and “Catastrophic” for impact.

You then place the various risks identified for your business within the matrix. This results in a simple visualisation of the most significant risks you need to think about.

For example, if you have a stall at the local open-air market selling handmade jewellery, theft could be a “Possible” risk with a “Significant” impact. This means it's something you need to look at right away. The matrix helps you figure out where to focus, making it easier to keep your business safe and sound.

Handle risks

Risk managers tend to adopt four main strategies to deal with business risk: avoid, mitigate, transfer, and accept.

Choosing the right strategy involves assessing individual risks and determining the approach that best fits with your business goals and capacity for risk.

Avoiding risks

Avoiding risk does what it says on the tin and involves changing your business strategies to sidestep potential issues.

To take a simple example, if you run an online travel company and you identify significant risks associated with tours in a region prone to natural disasters, you might choose to avoid these risks by no longer providing services in that area.

This direct approach prevents the risk, safeguarding your clients' safety and your agency's reputation by steering clear of foreseeable troubles.

Mitigating risks

Risk mitigation involves taking steps to reduce the impact or likelihood of a risk to your business.

Let’s imagine you own a restaurant. To mitigate the risk of contamination, you could implement robust food safety protocols, going beyond the requirements of the Food Standards Agency to require all staff to undertake advanced hygiene training.

By doing so, you're lessening the chances of a health incident that could harm your customers and damage your business's reputation.

Transferring risks

Transferring risk involves shifting the responsibility for potential problems to another party, often through insurance or contracts.

For example, as a coffee shop owner, you might transfer the risk of equipment failure by securing a rapid response repair contract. With such an agreement in place, if your coffee machine breaks down, the service provider is responsible for timely repairs or replacement, minimising downtime.

This strategy ensures that your business operations continue smoothly without bearing the full burden of emergency repair costs or extensive lost sales.

Accepting risks

Not all risks need to be avoided, mitigated, or transferred. Sometimes, accepting a risk is the smart choice, especially when prevention costs outweigh potential losses.

For instance, as an independent bookshop owner, you might accept the risk of stocking a controversial new book if the expected hike in sales surpasses the risk of losing a few customers.

Risk acceptance is best for minor risks and those with low financial impact, or as part of a calculated business growth strategy.

Monitoring and reviewing risks

Small business risk management is an ongoing process. Regular monitoring and review are important to manage potential threats and adapt to new challenges effectively.

Let’s say you open a food truck serving freshly made gelato in a busy seaside town. Consistently tracking local events can help you to adjust your staffing and stock ingredient levels to meet demand.

By staying ahead of the risks while remaining flexible and willing to adjust your strategies, you can continue to provide excellent service while maximising profits.

Proactive risk management techniques

Managing risks proactively is a smart approach. Let’s explore how to stay ahead.

Build risk awareness

Creating a culture of business risk awareness is a bit like forming a Neighbourhood Watch group. Just as community members are encouraged to report suspicious activities to improve safety, your employees should be empowered to identify and communicate potential risks.

Establish a workplace culture where employees are encouraged and rewarded for speaking up about risks and suggesting improvements. Conducting regular training can help staff recognise and feel confident to report concerns, so this is also a good strategy to implement when thinking about how to motivate employees.

Leverage technology

Tech can play a big role in mitigating business risks. Take cash flow, which can be a pain point if you don’t provide customers with diverse payment options, or if there’s a delay in actually receiving the money into your account.

You can lower risk of issues arising by utilising software and hardware solutions for efficiently accepting and promptly processing payments. These can include online Payment Links which allow customers to pay via social media and SMS links, and portable card readers which let you take cashless payments in person.

These kinds of tech tools can bring real peace of mind when it comes to your daily cash flow.

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Learn from mistakes and successes

Both success and failure can provide valuable learning opportunities for small businesses.

As a small business owner, you can explore situations where things went awry to learn what went wrong and improve future strategies. For example, if certain techniques didn't motivate your team, analysing these can help you develop more effective methods.

Similarly, when strategies succeed, such as those relating to how to get clients, you should examine these too to understand what worked well and why.

This approach helps you to rectify mistakes and reinforce successful tactics. Creating a workplace where mistakes are viewed as learning opportunities rather than failures builds resilience and encourages innovation among your team.

Financial safeguards

Navigating the financial challenges of running a small business can be complex, and not just when you’re looking into low cost business ideas

When exploring how to start a business of any kind, it’s wise to have the right financial safeguards in place so you can shield your venture from unexpected setbacks, helping to ensure its stability and security.

Business insurance

Whether you’re launching a sole trader business, forging a partnership or setting up a limited company, investing in suitable business insurance can help protect your assets and ensure business continuity.

Insurance policies can cover a range of pitfalls, including potential property damage, negative repercussions of professional services, and employee-related risks, so you should carefully select coverage which aligns with your business activities.

Regularly reviewing insurance policies will ensure they continue to meet the needs of your small business, providing peace of mind as you focus on how to make extra money or how to grow your business.

Financial planning

No matter if you’re exploring how to start an online business or running a high-street shop, proper planning is a key part of protecting against financial risks.

Effective bookkeeping for small businesses will help you keep track of your cash so you don’t inadvertently find yourself spending beyond your business means. You might choose to set aside profits into a reserve fund, so you’re better prepared for, say, a lull in sales or other unexpected financial challenges.

Having access to cash reserves can also be useful if you’re contemplating setting up passive income ideas or looking at ideas for second income streams to supplement your main business revenue.

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How to recover from a financial setback

Even with meticulous planning, the unexpected can happen, causing financial setbacks for your business. But don't worry; with the right approach, it's possible to bounce back stronger.

Here are some practical tips to help you steer your small business through tough times and get things back on track.

Assess the damage

Conduct financial analysis to understand the extent of the financial impact and how it affects your business. Review financial statements and identify areas where costs can be reduced to make up for the shortfall.

Revise your budget

Implement changes reflecting your new reality, perhaps revisiting how to price a product or how to price a service to quickly increase sales. Cut non-essential expenses and focus on core business activities that generate revenue.

Communicate with stakeholders

Stay transparent with employees, suppliers, and customers. Nurturing a positive workplace culture, maintaining a solid marketing strategy for small business success alongside related customer acquisition strategies can be pivotal during recovery periods. Be upfront and remain open to possible solutions or adjustments.

Seek professional advice

Consulting with financial advisors can be helpful, especially if your initial business plan didn't account for such setbacks. Professionals can provide immediate guidance and help you navigate the recovery process going forward.

Consider alternative revenue streams

Exploring how to start a side hustle or how to make money online might provide you with ideas for alternative revenue streams. Some financial risks can be averted simply by reducing your business’s dependency on a single source of income.

Plan for the future

Post-recovery, start planning for the future. Identify what caused the setback and develop strategies to prevent similar situations. This could involve refining your marketing strategy or, say, learning how to use social media for small business to enhance visibility and attract new clients.

Embracing risk

As we touched on earlier, embracing risk isn’t just about facing fears; it’s about spotting chances for growth and innovation.

This can be particularly important when at the start of your business journey. For example, when exploring how to start a business from home or pondering low cost high profit business ideas, a degree of risk-taking will be necessary for taking your enterprise from the concept stage to a real, bona fide, money-making endeavour.

Later on, embracing risk can be necessary for seizing new business opportunities. Imagine a small craft brewery that expands its range into non-alcoholic beers – a big risk given its established customer base. Through detailed market research and a good understanding of how to do a competitor analysis, the brewery identifies a growing trend towards healthier lifestyles.

This well-considered risk opens up new markets for the brewery, significantly boosting their customer acquisition rates and sales numbers.

Cultivating a risk-taking mindset is about finding the right balance between caution and courage. Here’s a few tips to help you make smart decisions.

Know your industry inside-out

Get to grips with your chosen industry. From understanding how to identify your target market to learning how to advertise your business, knowledge reduces uncertainty and builds confidence.

Learn from others

Connecting with peers through small business networking events can be an invaluable way to gain insights into how to run a business. You can share experiences, get advice on pricing strategies and much more besides.

Plan thoroughly

Every risk should be accompanied by a solid plan. Ensure you know how to write a business plan that sets your small business finances up for success.

Start small

Not every risk has to be big. You can start with smaller risks like trying small business crowdfunding. This approach comes with the possibility that you won’t meet your funding goals, but executed correctly it could boost brand awareness without risking your bottom line.

Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.

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