Establishing a business can be risky, and it’s this risk that stops many would-be entrepreneurs from taking that next big step. These same entrepreneurs, though, also stand to enjoy precious rewards such as economic wealth, growth, and innovation. In this blog, I’m going to share some tips for how to manage risk in business, regardless of the industry you belong to. This is one of many entrepreneur skills you’ll need if you want to find success.
How to Manage Risk in Your Business in 5 Steps
1. Understand the nature of your company and identify the risk.
As an entrepreneur, you first need to look at the bigger picture. If you plan to open an e-commerce store (which can come with incredible margins), investing in too much inventory right off the bat can be risky. While it can be tricky when you don’t have much data to work with, you want to try to estimate and forecast how much inventory you’ll want to keep in your store at a time. Excess inventory that doesn’t sell means you’re tying up cash in product that doesn’t move.
If you’re opening a restaurant, consider the size of the location, the number of staff members it’ll take to maintain it each day, and again, how much product you’ll need to keep your customers happy. These elements are critical as they directly involve and impact your daily finances and monthly operating costs.
2. Consider changing your business structure.
You can limit your liabilities by changing the structure of your business from a sole proprietorship to a corporation or Limited Liability Company (LLC). In a corporation or LLC structure of business, the owner isn’t personally liable if the company incurs any debts or other liabilities.
Study and understand the structure of your business and what options you have. Don’t forget, too, that corporations and LLCs have different sets of requirements when registering. So, the process will be different.
3. Keep a handle on growth.
Monitor your finances by preparing financial statements that summarize the business’s revenue, expenses, and profit during a specific period. It’s important to generate these statements in different accounting periods to reflect the true meaning and value of your business.
For example, revenue may grow for a specific period but could drop during another season. Operating expenses may increase in some months due to the volume of customers or extended working hours, while they can also decrease in other months. (Think of how much our shopping habits change leading up to the holidays, and how businesses must adapt to accommodate that each year.)
There are three financial statements that you must prepare if you are running a company:
- P&L statement – shows the revenue and expenses of a company; profitability is also determined here.
- Balance sheet – displays the company’s assets and liabilities; investors use this in comparing the strength of a company’s assets against its liabilities.
- Cash flow statement – manages the company’s cash position and shows the amount of cash available to pay for the company’s debt and operating expenses.
4. Monitor growth.
Growth can be deceiving. The more money you make, the more you need to spend to sustain it. This is a good thing for entrepreneurs, but you do need to take care to monitor your growth closely so you understand how much more you’ll need to invest in your staff and inventory.
For example, more traffic to your e-commerce store might mean needing to hire more customer service team members. It could also mean needing to increase your inventory orders with your suppliers. Yes, you’ll be spending more money, but you should be making much more, as well. Your staff and inventory are an investment.
5. Calculate your cash runway.
Cash runway will help you understand if your business is financially sound or in shaky territory. “Runway” essentially refers to how long you could pay the bills if your business was to stop making money right now. Would you have enough to keep running for one month? Six months? One year?
This is an important metric and it’s being more heavily acknowledged by start-ups (more so in the new normal after COVID-19), especially those who receive funding from external investors. To be more specific, there are actually three different ways to identify cash runway:
- Company cash – reflects if your company has enough money to pay all expenses.
- Team cash – determines your capability to pay for employee wages. Consider offering equity or non-cash incentives.
- Founder cash – reflects how long you can operate at a negative P&L status.
Having runway is so vital because you will have time periods or seasons when revenue dips. It might not be drastic, or it could put immense pressure on your business. You need that cushioning, that security blanket of extra money lying around just to be safe. The last thing you want to do as an entrepreneur is have to make important decisions with your back against the wall.
This list isn’t exhaustive but gives you a few things that you need to note when starting up a business. Always remember that being an entrepreneur almost always comes with at least some risk. But, as you now know, there are plenty of things you can do to manage this risk. Learn how to innovate, adjust, and anticipate the needs of your business to deliver amazing results and continued growth opportunities.
Now that you know how to manage risk in business, which of these tips will you apply first?