When most business owners hear the term "risk management," they think of property and casualty insurance. And while an adequate level of insurance is part of a good risk management plan, there are many aspects of a business in which daily risk decisions must be made. For instance, decisions involving computer system purchases, hiring of employees and even where and what to advertise all involve various levels of risk management.
A good risk management system for your business involves a three step process. First, you must recognize the risks that you face. Second, you must devise a plan to mitigate these risks. And third, you must execute on this plan. The recent catastrophes caused by Hurricanes Katrina and Rita provided horrific case studies of the importance of a good risk management system. Most of the businesses that had prepared with this three-step process survived in some form. However, the businesses that had not properly considered risk management issues generally suffered fatal damage.
For construction company owners, nearly all risk management decisions can be narrowed down to six key areas: operational, reputation, regulatory, legal, liquidity and disaster.
Operational risk is concentrated in three areas: 1) equipment; 2) information risk; and 3) human risk. If your equipment is older and prone to high maintenance expense, then your operational risk is high. Frequent equipment problems can lead to high levels of downtime and waste, both of which can be very expensive. If you have had significant problems with your equipment, you should consider replacing it. While the initial cost might seem prohibitive, you might actually find in putting a pencil to it that the improved productivity and efficiency would more than cover the cost of the new equipment.
Information risk pertains primarily to your computer system. If your system is antiquated and slow, then you are taking undue risk in the quality and availability of your information. For instance, your system should be able to provide up-to-date inventory records. Without this information, you might underestimate the availability of certain items. Your system also should provide you with frequent profit-and-loss information, so you know how your business is performing.
Information risk also involves frequent backups of your data to ensure that it isn't lost in the event of a fire or power outage. To mitigate this aspect of information risk, you should backup your data on a regular basis (a state-of-the-art computer system should be able to backup the information daily) and store the backed up data at a different site or in a fireproof safe or vault.
The third area of operational risk is human risk, which can manifest itself in the form of human error, fraud or an excessive reliance on the impact of one or two key employees. Human error risk can be mitigated by well defined policies and procedures, good training and targeted hiring practices. Employee fraud can be prevented by thorough and targeted hiring practices and good checks and balances in your cash control system. And you can avoid excessive reliance on one or two employees by cross-training and well documented policies and procedures.
Reputation risk is one that is often over-looked, but one that can have a significant impact on the viability of a business. A good reputation is hard to obtain, but easy to lose. The best way to keep up a good reputation is by striving to under-promise and over-deliver.For instance, if you are out of a certain inventory item and must order if for a customer, don't promise it will be in within three days when it normally takes five.
You also can significantly impact your reputation in the type and content of advertising you do. Since your advertising dollars are limited, use them to emphasize a trait or traits which differentiate you from the competition.
The devastating hurricanes in Florida in 2004 and in the Gulf region in 2005 certainly highlighted the critical importance of disaster risk management. And it is important to note that disaster risk management is not just about maintaining a comprehensive insurance plan. Here are some tips on mitigating the various disaster risks for asphalt contractors:
- Hazard and contents risk: Make sure you are adequately insured against fire and theft. Keep good records of the value of your assets in case you ever must make a claim. Also, this will ensure that you do not over-insure or under-insure the value of your assets.
- Other insurable risks: Additionally, you need other insurance such as Liability Insurance, Business Interruption Insurance and Workers' Compensation Insurance. A good insurance agent should be able to assist you in purchasing the right types and amounts of coverage.
- Natural disaster risk: If your business is located in a flood zone, flood insurance should be purchased, and your inventory and other assets should be stored above potential flooding areas in the building. If you are located in an area that is prone to earthquakes (see Northern California), your building construction and equipment installation should be done to mitigate this risk.
- A contingency plan: You need a contingency plan to help you through any disasters that might strike. The contingency plan would include alternative sites for your shop, an evacuation plan, fire prevention training for employees, storage of backed up computer data off site or in a fireproof safe or vault, and key contacts in the event of a disaster.
With all of the corporate governance issues that have taken center stage following the scandals brought on by Enron, Arthur Anderson and others, publicly traded companies have experienced a full dose of regulatory risk in recent years. But public companies are not the only ones that must manage regulatory risk.
Alice Magos writes the online column, "Ask Alice," for the CCH Business Owner's Toolkit (www.toolkit.com), providing advice on a variety of subjects involved in running a business. "The minute you become an employer, you become subject to a host of federal labor laws, not to mention OSHA regulations and an assortment of other federal agency rules," explains Magos.
For example, all employers must comply with federal laws such as FLSA, FICA, FUTA, ERISA and the Equal Pay Act. And depending on your number of employees, you may have to comply with laws such as COBRA (20 or more employees) and the Family Medical Leave Act (50). These laws mean complying with requirements for important things like payroll withholdings, overtime pay and the display of posters for EEOC, the Federal Minimum Wage Notice and others. The penalty for non-compliance with these regulations can be stiff fines or even jail.
The bottom line with regulatory risk is to stay informed. Keep up with industry specific and general regulatory issues and by staying in touch with your CPA and attorney.
The laws that govern commerce in the United States are vast and complex and create a certain level of legal risk for all businesses, regardless of size or industry. Many of these legal risks can be mitigated, but Magos advises that the best method for mitigation is to choose one's associates wisely.
"Check out everyone you do business with; employees, vendors, suppliers, customers, advisors and investors," advises Magos. "Dealing with honest and non-litigious folk is a good beginning."
In addition to dealing with the right people, Magos offers the following practical ways to mitigate legal risk:
- Get everything in writing: While most business owners obtain formal agreements such as leases, contracts and employment documents, Magos advises using the same approach for less formal agreements, such as changes in a customer order. "Anything that could come back to bite you needs to be documented," she says.
- Prevent escalation of minor gripes: Many major legal battles start out as a seemingly mino disagreements. Magos says that common sense, good communication and prompt attention should keep most small misunderstandings from being blown out of proportion.
- Don't be a do-it-yourselfer: Just as you would not expect an attorney to be able to successfully produce varietals of wine, you should avoid trying to settle legal matters on your own.
- Maintain good, solid insurance coverage: Good insurance coverage will protect you against product liability claims, as well as any other claims that you might face. The insurance company will also hire legal representation for you in court in case you ever get sued over a liability issue.
- Insert an arbitration clause into contracts you enter into: Arbitration is far less costly and time consuming than litigation.
- Operate your business in a sensible manner: Magos says this just means doing the obvious things to preserve life and limb and property. For example, shovel snow promptly, remove tripping hazards, have machinery inspected often, insist on safety rules being followed and treat everyone fairly.
Simply stated, liquidity risk is the risk that you will run out of the cash necessary to sustain your business. And while there are a number of complicated factors that can impact your company's ability to remain solvent, there are three scenarios that typically cause a financial crisis: 1) excessive losses; 2) a mismatch of assets and financing sources; and 3) rapid sales growth.
If you are starting a new business or if your existing business is expanding with new locations or new lines of business, run your projections based on conservative assumptions. You should be able to estimate potential sales with the input of industry consultants and your CPA and banker. And it's critical that you keep operating expenses in check during your start-up or expansion period by watching every dollar that goes out the door.
A mismatch on the balance sheet can be equally devastating to a small business. For instance, you should not use operating cash or a short term line of credit to finance fixed assets such as real estate, equipment and vehicles. These assets should be financed by permanent equity or long term debt, or even a lease. Fixed assets will not generate cash flow quickly enough to replenish operating cash or to pay back short term debt when it comes due, and a liquidity crisis will surely follow.
An often overlooked threat to liquidity is rapid sales growth. While sales growth generally is a good thing, in excess it can sink a business. Rapid sales growth leads to rapid increases in inventory. If this is not properly planned for, a business can quickly run out of cash and line of credit availability. And if you are caught off guard by substantial growth, then your banker will be as well, which may well lead to a crisis if the lender is unwilling to increase the line availability. The other risk you run with unchecked sales growth is shortages of inventory, which will certainly hurt your reputation in the market (see above Risk #2).
Planning is key
In summary, risk management is all about putting together a well developed plan and then executing on that plan. If you look at most of the areas of your business as subject to a risk assessment, you will find that your business will run far more smoothly on a day-to-day basis. And a smoother running business means fewer crises, more profitability and more sleep at night for you.