Three Risks Small Businesses face and how to combat them

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Any new business there is an element of risk involved. After all, taking the plunge and setting up on your own is a huge step and one that should be taken seriously. A lot of thought needs to be given to the type of business you plan to start, the target demographic and whether you have a unique selling point (USP) that will put you a step ahead of the competition.

While there is bound to be risk involved when a new business is conceptualized, there are ways in which these risks can be minimized. It may be tempting to ignore risks related to legal, financial, or staffing issues, but it’s better to know how to deal with them, and how to prevent them so that you don’t face problems in the future.

For example, while you should hopefully never face the prospect of bankruptcy, having a financial plan in place will help to minimize the risk of debt and the serious impact it can have on your business. Risk management may seem daunting, but if you break it down into stages, it shouldn’t be too difficult.

Financial risk

Money matters can be the bane of your business’ existence if you don’t get things in order. Both external and internal factors can hugely affect your cash flow and impact substantially on the chances of success.

Before you even start your company, you need to create a foolproof business and financial plan that you can use when chatting to financial providers, or refer to for your own benefit. Planning your financial projections will give you more of an idea of what to expect, while minimizing the risk of fumbling blindly into the future.

Make sure that you have the right amount of start-up funds available to you so that you know you can afford to run with your venture. If you don’t have the funds yourself, it’s recommended you chat to an advisory for help.

Those who can’t secure financing tend to use their own personal savings but remember that if the business fails, you also risk losing out personally.

Legal risks

The last thing a small business owner will want to face is legal proceedings. You could be sued for any number of reasons: failing in a duty of care to a client; a service or product you provide not performing as a client expects; a member of staff suffering an injury at work; a member of the public tripping over a piece of office equipment at your premises; or even you spilling a cup of coffee over a client’s computer. What about that picture on your website? Do you have the relevant copyright? And where did you get the idea for your business? Someone could claim that you are infringing their intellectual property.

Again, good risk management here is essential in identifying the potential risks your business faces and taking precautions which can range from providing a safe working environment, to making sure you have permission to use any third party imagery on websites for example.

You will also need to ensure that all the necessary business insurance is in place. Some areas of cover such as employer’s liability are mandatory for virtually every business that has employees. Other policies such as professional indemnity are often required by clients as a condition of working with them. Additional areas of cover include public liability and product liability as well as cover for office buildings and contents.

Staff risk

Investing in that first employee is often one of the biggest decisions any small business will take. Not only is there the financial commitment of a regular monthly wage to pay – regardless of how the business has done that month – but there are swathes of policies and procedures that come with taking on employees.

You have a legal duty to provide a safe and comfortable working environment. Government bodies such as the Health and Safety Executive provide useful risk assessment information to make sure health and safety isn’t compromised and that you stay within the law. As mentioned, employer’s liability cover is usually mandatory.

Staff training of course will be essential to make sure that the service your business delivers continues to be of high quality and your clients don’t have cause to complain, or, even worse, sue you.

Staff fraud and dishonesty can also be an unfortunate consequence and again, you will need to have procedures in place to prevent it from happening and deal with it if it does.

Ensuring success

Many new businesses fail not because the product or service was a failure but because they failed to proactively tackle the key areas of risk that come with setting up any business. If you can identify the risks and deal with them before they become an issue, you will be well on the way to a fruitful future as a business owner.

What are difference between Business Risk and Financial Risk

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The risk is the possibility of loss or danger. The equity shareholders have to go through with two types of risk, i.e. Business Risk, and Financial Risk. The former is the risk related to the business of the entity while the latter is the risk due to the use of debt funds. However, if there will be no risk there will be no profit and the higher the risk; the more will be the chances of getting high returns. In this article, we have compiled the substantial differences between business risk and financial risk considering various parameters.

Definition of Business Risk

Business Risk is the probability of earning a comparatively low profit or even suffer losses because of changes in the market conditions, customer demands, government regulations and economic environment of business. Due to such risk, the firm will not generate enough profit to meet out its day to day expenses. The risk is unavoidable in nature.

Every business organisation operates in an economic environment. The economic environment includes both micro and macro environment. The changes in the factors of the two environments directly influence the business, and the risk arises. Some of those factors changes in customer tastes and preferences, inflation, change in the policies of the government, natural calamities, strikes, etc. The business risk is divided into various categories:

  • Compliance Risk: The risk arising due to the change in government laws.
  • Operational Risk: The risk originating due to the machinery break down, process failure, lockouts by workers, etc.
  • Reputation Risk: The risk emerging as a result of any misleading advertisement, lawsuit, criticism of bad products or services, etc.
  • Financial Risk: The risk arising due to the use of debt capital.
  • Strategic Risk: Every business organisation works on a strategy, but due to the failure of strategy the risk arises.

Definition of Financial Risk

Financial Risk is the uncertainty arising due to the use of debt finance in the capital structure of the company. The capital structure of the company can be made up of equity capital or preference capital or debt capital or the combination of any. The firm, whose capital structure contains debt finance are known as Levered firms whereas Unlevered firms are the firms whose capital structure is debt free.

Now, you may wonder that debt capital is one of the cheapest sources of funds, then how will it become a risk for shareholders? Because at the time of winding up of the company the creditors are given priority over the shareholders, and they will be repaid first. So in this way, the risk arises that the company will not be able to fulfil the financial obligations of the shareholders due to debt financing. Moreover, financial risk does not end up here as it is a myriad of risks which are given as under:

  • Market Risk: Risk arising due to the fluctuations in the financial assets.
  • Exchange Rate Risk: The risk arising out of the variations in the currency rates.
  • Credit Risk: The risk emerging because of non-payment of debt by a borrower.
  • Liquidity Risk: The risk originating as a result of a financial instrument is not traded quickly in the market.

Key Differences between Business Risk and Financial Risk

The following are the major differences between business risk and financial risk:

  1. The uncertainty caused due to insufficient profits in the business due to which the firm is not able to pay out expenses in time is known as Business Risk. Financial Risk is the risk originating due to the use of debt funds by the entity.
  2. Business Risk can be evaluated by fluctuations in Earnings Before Interest and Tax. On the other hand, Financial Risk can be checked with the help of leverage multiplier and Debt to Asset Ratio.
  3. Business Risk is linked with the economic environment of business. Conversely, Financial Risk associated with the use of debt financing.
  4. Business Risk cannot be reduced while Financial Risk can be avoided if the debt capital is not used at all.
  5. Business Risk can be disclosed by the difference in net operating income and net cash flows. In contrast to Financial Risk, this can be disclosed by the difference in the return of equity shareholders.