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Your business plan should indicate your risk appetite

Guest post by: Michiel Jonker

Article Overview: It is important to determine your risk tolerance while busy writing your business plan. It will establish your attitude towards profit erosion and tell investors if you are serious to protect the profit that you will generate by pursuing your business opportunities. By establishing your risk appetite, you will also know to which extent you should and are willing to protect your profits. As a result, you will also profit from your business risks!

Your business plan should indicate your risk appetite

May I ask, what is your risk appetite (or tolerance)? Because one of the most important parts of running a business is determining your own risk appetite - i.e. how much profit are you willing to lose? When presenting your business plan to potential investors, they would like to know with what type of entrepreneur they are dealing with. In other words, they would like to establish if you would let your risks, eroding your profit, "go wild" (i.e. unmanaged) in your company or if you have already dealt with this aspect in your business plan and know exactly which risks are "worth" monitoring (in order to reduce the possible occurrence and impact of them) and that the cost associated with controlling your risks, is not more than the potential negative financial impact of the identified threats.

Knowing your risk appetite is one of the keys to business risk management and success. In short, a risk is anything that has the power to erode your profits, i.e. any event, action, decision, lack of action or decision as well as any circumstance in- or outside of your company that causes or could cause profit erosion. You would normally encounter risks of strategic, operational, financial and legal nature.

By implementing controls to counteract her identified risks, a business owner or manager has reasonable assurance that her profits and potential profits will be protected. DEFINITION OF A CONTROL - A control is any countermeasure that gives reasonable assurance that it will 1) prevent the occurrence of identified risks; OR 2) detect the occurrence of identified risks; and then 3) correct the negative impact (i.e. the loss or damage) as well as the consequential negative financial impact of the identified risks that have occurred.

Please pay attention to the words reasonable assurance. No control can give a business owner absolute assurance that it will prevent or detect a risk completely. The objective of the business owner is, however, to minimize profit erosion to an acceptable level; in other words a level corresponding to her risk appetite (i.e. her appetite for profit loss or how much she is prepared to lose).

To counteract vulnerabilities in your business strategies and systems, you should use policies to enforce the right procedures, standards, business structures and systems. In other words, a control is any countermeasure and can be a policy, system or strategy. To counteract your lack of business strategies and systems, you should implement, obviously, the necessary business strategies and systems.

Assessing both ends of your risk appetite while writing your business plan is quite possibly one of the most important decisions you can make. How should you do that?

First, you need to calculate the negative financial impact of your risks (i.e. the profit erosion in monetary terms). Secondly, you need to calculate the cost of current or possible countermeasures (controls) - so as to determine whether or not your countermeasures are justified on a sound economical basis.

We discuss these calculations in more detail in our business plan guide.

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Article Tags: business controls, business countermeasures, business opportunities, business plan, business risk, investors, profits, risk appetite, risk management, risk tolerance



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