Risk Management

Share the risk.

Get insurance or have a different company handle this activity and take responsibility for it.

Reduce the risk.

Make changes so that the risk is less likely to happen or less likely to be severe. Creating good internal policies for health and safety and for quality control are ways to reduce risks.

Quality control

Quality control is when you make procedures to control the quality of your product or service. It may involve having testers try out the product to make sure it works properly. This can help you avoid lawsuits against the product or service in the first place.

Avoid the risk.

This may not be possible for many of your company's risks, but if a risk is avoidable and not worth the possible negative outcome, this may be a good strategy.

Marginal costs and benefits

While running a business, you also have to determine the cost and benefit of producing or providing units of your product or service.

Sunk costs

are expenses you spent money on in the past that are unrecoverable, meaning you can't get that money back. These shouldn't be part of the decision whether to abandon the investment, since you can't get that money back either way. When an entrepreneur has spent a lot of money on sunk costs, it can be emotionally difficult to give up on a particular attempt at something, whether that is a product, goal, or even an entire company. However, it is usually best to make financial decisions based on current and future prospects, not on past decisions or expenses.

OSHA (Occupational Safety and Health Administration

is a U.S. government agency that creates and enforces standards for workplace health and safety. These standards are called health and safety regulations.

Marginal benefit

is the amount that people are willing to pay for each additional unit of a product or service. As long as the marginal benefit is greater than the marginal cost, it makes sense to continue making additional units of a product. If the marginal benefit is lower than the marginal cost, it wouldn't be worth it to the company to produce additional units of the product.

Internal policies

A small business can create policies and procedures for employees to follow that will help control risk internally.

Accept the risk.

Accept the risk and budget for it appropriately.

2. Choose a strategy.

Decide how you will handle each of the risks you listed. Some common strategies for managing risks include:

Insurance

Getting insurance is a good way to manage many kinds of risk, as long as the insurance premium is worth the protection it provides. Some insurance is legally required, such as a state requiring a certain amount of car insurance for driving a car. A small business can purchase business owners' insurance, which is a package of insurance that provides a variety of protections that a small business may require. Types of insurance that a small business is mostly likely to need include: Liability protection against lawsuits. General liability provides protection against most types of lawsuits, and product liability protects against lawsuits that claim injury or damage caused by the company's products or services. Home-based business insurance for protection of business equipment and materials stored in the home. Internet business insurance for Web-based businesses, to protect against damage caused by viruses and hackers. It may also cover protection against lawsuits related to Web activities. Worker's compensation, which is required in every state except Texas. It pays for medical expenses and missed wages if an employee is injured on the job. The amount of coverage required varies by state. Criminal insurance, to protect against theft and damage caused by criminals. Business interruption insurance, for protection against lost income during times when natural disasters or other events cause the business to shut down. Key person insurance, to protect against the loss of an important employee.

Controllable risks

are risks that a small business can control internally, such as its choice of employees, internal organization, policies, and procedures.

Uninsurable risks

are risks that insurance companies are not willing to provide insurance for. Most speculative risks are uninsurable, because they are difficult to predict and the possibility for loss is high.

Pure risk

is a risk of something negative happening. There is no possibility for profit or gain. Either things will remain the same, or something bad will happen. Pure risk is also called static risk. Examples of pure risk include injury, sickness, premature death, unemployment, car accidents, and property damage due to natural disasters such as fire, flood, or earthquakes. People don't usually have much choice about whether to take pure risks. They are usually risks involved with everyday human life, or in living in a particular society or geographical area. If most people in an area are using public transportation, their risk of being in a car accident is lower than if they were driving frequently. And certain geographical areas are more likely than others to experience natural disasters, such as earthquakes, tornadoes, or floods.

Health and safety regulations

are rules for employers and employees to follow in order to keep their workplace healthy and safe. It is illegal to disobey OSHA's health and safety regulations. If regulations are not obeyed, OSHA can fine the people responsible, or take them to court for committing a crime. Some of OSHA's health and safety regulations have to do with maintaining a safe work environment. For example, some regulations make sure that dangerous materials are kept in safe containers. Other health and safety regulations created by OSHA have to do with how things are done, like turning electronic equipment off before attempting to fix something so that no one gets an electrical shock. Each state has health and safety regulations, too. OSHA's regulations and the state regulations work together to make the workplace safer. The health and safety regulations that affect you depend on the state you live in. In addition to following the required health and safety regulations, a small business might form other policies and procedures to protect its employees and customers, depending on the type of company, the location, and many other factors.

An insurance premium

is the amount that the person or company must pay the insurance company in order to get insurance. In return for the premium that you pay to the insurance company, the insurance company agrees to pay for the costs if the risk turns out to have a negative outcome.

Risk management

is the attempt to protect against risk by identifying and minimizing it. This is very important for a small business, because without proper planning, a single risk with a negative outcome can severely damage a company, making it difficult or impossible to recover.

Marginal cost

is the opportunity cost to the company of producing each additional unit of a product. The marginal cost is the cost of the next highest value item that you could produce or provide with the money you would have spent making one unit of the original item. For example, if your company makes watches, the marginal cost is the cost of the next highest value item you could make with the money you would have spent on making one watch.

Costs of running a business

After you start a company, it's important to continue considering the opportunity cost, to make sure that it's still worth it to be investing your time and money into the business instead of in other opportunities. When considering other opportunities, it's difficult not to be emotionally swayed by the amount of time and money you have already put into the business and will be unable to get back.

Insurable risks

are risks that insurance companies are willing to provide insurance for. Insurance companies usually only agree to insure risks that: Are predictable by analyzing statistics of groups. Have negative outcomes that can easily be measured financially. Are unlikely to have negative outcomes with such high costs that people would be unwilling to pay the premium. Are random on the individual level, so the person or company being insured is unlikely or unable to intentionally cause the negative outcome to happen. Insurance companies will usually only insure against pure risks, because pure risks are more predictable.

Your insurance coverage

is the amount that the insurance company is willing to pay. There may be a maximum amount the company will pay, or it may agree to pay all costs above a certain amount. You may be required to pay a percentage of the costs or to pay all costs under a certain amount.

The opportunity cost

of an investment is equal to the value of the next most valuable opportunity. For example, if you are starting a small business, the next most valuable investment might be investing in stock. By starting a small business, you are giving up the opportunity to invest that money in stock, and the potential profit that could bring you. When making a financial decision, consider the value of other opportunities, and make sure that you are choosing the opportunity that you think will be most valuable. The potential for and probability of profit in starting a new business should be better than the next most valuable opportunity. When starting a new business, some ways that you may be able to reduce risk include starting a franchise, buying an existing business, or taking over or expanding an existing family business. This may reduce the risk of failure if you are starting a franchise or taking over a business that is already well- known and successful.

Legal assistance

As a small business owner, you can research and follow many legal procedures yourself, such as getting a business license and a DBA name. For complicated legal procedures or lawsuits, it's usually best to get assistance from a lawyer who will advise and represent your company. If you are making a legal agreement with another person or organization, a lawyer can help write the contract. A contract is a written agreement that can be legally enforced. Make sure to get a lawyer who is trustworthy and affordable. Some good ways to find a lawyer are by asking people you know for recommendations, or by reading reviews of lawyers on the Internet.

1. Identify risks.

Determine which risks this particular company is likely to face. This varies by company, depending on the type of company, its location, and many other factors. Some types of companies are more likely to experience lawsuits than others. Some are more likely to pose a safety threat to customers or employees. For example, a company that makes toys for small children may face lawsuits if the toys ever pose a danger to the children. This company is probably more likely to face a lawsuit than a person who draws illustrations for books. Depending on your location, your company may be more or less likely to experience a natural disaster. Make a list of all the risks your company is likely to face, with notes about how severely these risks could affect your business.

Natural risks

are risks caused by nature. Environmental factors such as climate and natural disasters can affect a small business. For example, an unusually cold summer might negatively affect an ice cream shop's sales, but a hot summer might increase sales. An earthquake or flood might damage a small business' property and equipment

Economic risks

are risks caused by the economy. Local, national, and global economic factors can affect a small business. A strong economy is good for most businesses, and a weak economy is usually bad for businesses. For example, a high unemployment rate may negatively affect a tourist shop, because fewer people have the money to spend on travel and souvenirs.

Human risks

are risks created by people. People can get hurt or sick, they can steal or be unethical, they can break the law or sue your company, and so on. Human risk can come from anyone who is involved with your company, including customers, employees, and others in the community who are affected by your company.

Uncontrollable risks

are risks that the business can't control, such as external economic factors, natural disasters, and so on. To get started on creating internal policies and procedures, a small business should learn and follow the U.S. Department of Labor's federal laws about worker health and safety, wages and hours, and so on.

Speculative risk

is a risk that has the possibility of profit or loss. Most financial investments are speculative risks. Entrepreneurship is a speculative risk because the main financial risk for an entrepreneur is the possibility of loss or failure. This type of risk can be helpful to society because it has the possibility of profit. A successful small business is good for the community and economy. Speculative risk can be difficult to predict, and loss is common. Speculative risk is taken by choice, in hopes of gaining a profit. It's easy to avoid speculative risk by not taking the risk. Avoiding speculative risk also means avoiding the opportunity for profit.

Insurance

is a type of risk protection that a person or company can purchase from an insurance company, also called an insurance provider.

Your insurance plan

is the agreement you have with the insurance company that includes all the details of your coverage. There are many types of insurance, including car insurance, health insurance, homeowners' insurance, business owners' insurance, and so on. If you get in a car accident or get sick, your car insurance provider or health insurance provider will pay for whatever amount of the costs they agreed to pay. To determine the premium that customers must pay, insurance companies analyze statistics of large groups of people to predict the probability of a negative outcome and the likely cost. This way, the insurance company can make sure it is receiving enough money in premiums to pay the cost of the people who experience negative outcomes. Sometimes, certain people are at higher risk than others, and the insurance company may charge a higher premium for the people who the company considers a higher risk. Your personal history and other personal factors about you will be used to determine the premium you pay. A person with a history of speeding tickets will probably have to pay a higher car insurance premium than someone with a perfect driving record. Young people usually have to pay higher rates for car insurance, because they are statistically more likely to have accidents than older, more experienced drivers.