Risk Analysis - A Key Section of Your Business Plan


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A professional business plan should include a discussion of business risks and challenges. Although every possible risk will not be identified and addressed, the business plan should discuss the most important ones and indicate how management will mitigate their potential impact on business operations. Identification and discussion of business risks and challenges, and having strategies in place to deal with them strengthens the plan, enhances management’s credibility and increases the confidence potential investors will have in the business plan and its financial projections. Being upfront and discussing potential business risks, rather than glossing over them, builds confidence in the company’s management.

Risk analysis is particularly important for start-ups and small businesses, whose objective in writing a business plan is often to secure capital to start the business, to secure additional working capital for operations or to raise money for expansion. Since they often have more limited operating histories, entrepreneurs and small business managers have not yet demonstrated their ability to cope with business risks. Potential equity investors and lenders expect their business plans to provide assurance that management recognizes these challenges and is prepared to deal with them.

Identification of Risks

The first step in the enterprise risk analysis process is to identify the internal and external threats that may stand the way of achieving planned results. For convenience, these threats can be classified into three broad categories. These are “general business risks” that are faced by all companies, “industry-specific risks” that are faced by companies within the industry and “company-specific risks” faced by the company itself. Within this framework, specific potential risks within each category can be identified and addressed. The major challenges are those that may adversely affect the company’s financial condition, forecast financial results and liquidity.

General Enterprise Business Risks

General enterprise business risks are shared by most businesses but their significance varies by company. In the case of start-ups or early stage companies, management must gain experience in managing operational, marketing and other problems that will arise. Potential threats include unexpected problems that may develop in quality control, distribution, marketing and promotion and other areas. Start-ups and early stage companies must also build relationships with customers and attract customers from competitors. Small but established companies have already gained experience dealing with these problems, reducing this business risk. The risk analysis section should mention these dangers and uncertainties, and the business plan sections relating to each risk category should have strategies to deal with them.

Although all companies face uncertainties associated with the general economic environment, some enterprises are less business cycle sensitive than others. The economic cycle risk of a food company, for example, may be less of a concern than is the case of a construction company. Banks are exposed to interest rate risks but many have in place strategies to mitigate those uncertainties. Some businesses are exposed to challenges posed by higher gasoline prices, while realtors are exposed to risks relating to lower home sales. The important thing is to identify which of these general business challenges could impact the business and have strategies to deal with them. Companies should have strategies to stabilize their business and continue to succeed despite unexpected changes in the economic environment.

The business faces dangers associated with natural disasters. These relate to changes of the weather and their consequences, such as time lost in production and distribution and resultant economic downturns that depress sales.

In the case of companies that offer proprietary products, there are uncertainties associated with ownership of intellectual property. It is important to have trademarked brand name and patent protection to prevent replication of company products or services, which could have an adverse effect on the company and affect the outcome of intellectual property rights disputes.

Industry Specific Risks

The risks and challenges section of the business- or project plan should discuss industry-specific risks. One of those challenges is industry competition. Although it is expected that competition will be mentioned as one of the risks, enterprise strategies for competing effectively should be outlined in the competition and marketing plan sections of the business plan. In the competition section, major competitors and their strengths and weaknesses are discussed, as well as the company’s strategic positioning. In the marketing plan, the company’s action plans for overcoming the competition are outlined.

Some types of businesses are more subject to litigation risks than others. Uncertainties are especially high for companies selling internally consumed products such as food, beverages and pharmaceuticals. Any business that involves customers physically visiting its place of business is vulnerable to “slip and fall” or other types of litigation. Even professionals who have no on-site business can be sued for alleged “errors and omissions” in their advice. The litigation risk is discussed and measures to reduce it, including safety precautions and insurance coverage, can be described to indicate that the risk is known and has been addressed. The company should include the cost of liability insurance in the financial forecasts.

Company Specific Risks

In the case of start-ups, there are uncertainties associated with raising start-up capital and maintaining sufficient funding. In many cases, operations cannot commence until sufficient funds are raised to fund the acquisition of property, plant and equipment and initial working capital requirements.

The risks associated with fixed cost structure of the business are company-specific because they vary from high to low, depending on the nature of the business. In some businesses such as manufacturing, there are high fixed costs because of the large investments in equipment and facilities. Companies with high fixed costs achieve profitability only after the volume of business builds to a point that the fixed costs are covered. Thus, any problems in achieving and maintaining sales levels beyond the breakeven revenue level would have an adverse impact on operating results. The risks and challenges section of the project plan should refer to the marketing section, where strategies to achieve required volumes are discussed. In a service business, this challenge is not as significant, as more costs are variable and can be more easily managed as business volume changes.

All companies have uncertainties associated with recruiting, retaining and managing human resources. In the management and human resources section of the business plan, the company should discuss plans to recruit additional key employees and senior management that are critical to achieving its forecast and operational goals. The risk management section should mention that the company may or may not be successful in obtaining experienced professionals in web site development, operations and other areas but reference sections of the business plan where strategies are outlined to address this issue.

In the case of start-up companies, success of the enterprise will be dependent on the continuing services of only one or two key managers who provide executive leadership. If for any reason these managers were not to fulfill their current leadership roles, the ability of the Company to achieve its forecast results would be adversely affected.

Conclusion

It is important that the business and financial risks be identified and discussed in the enterprise business plan. The informed reader, especially one who may be asked to provide capital for the business, wants to be comfortable that the management has considered potential risks and developed strategies to deal with them. In the process of developing the business plan, identification of potential risks will not only result in a better plan but also better prepare management to successfully manage the enterprise. Readers will have a less favorable view of a written project plan that does not include a risk analysis section than one that demonstrates that management is aware of uncertainties and is prepared to take actions to address any threat.

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