The Relationship Between Profit & Risk

Risk is a given every day you open your doors for business. While you may be fully aware there is a relationship between profit and risk, however, it is important to understand that this relationship is not always the same. Some you can mitigate and some you cannot, and many times the risk you cannot is what directly connects to and creates the best potential for profit.

Insurable risks are characteristically random in nature, have a set financial cost and generally are those from which your business can recover. These have a low relationship to profit, because of the fact that you can – and sometimes must – purchase insurance that prevents it from affecting your bottom line. In addition, insurable risks are not unique to your business. Just as you purchase insurance and build its cost into your pricing structure, so does your competition. This negates any effect insurable risk has on pricing and ultimately on profit.

External risks are risks over which you have little to no control. The most significant external risk you face – and one that has a direct relationship to profit -- is business-to-business competition. Changing technology requirements are another external risk, but here the relationship to profit depends on how heavily your business relies on staying in line with current technology. If it does, failing to keep up with changing technology requirements puts your business at a disadvantage and will affect profit to a greater degree.

Internal risks are generally risks you can control. Because of this, they have a direct and significant relationship to profit. Internal risks include both financial and operational risks such as capital funding, credit and debt collection, internal controls, safety and quality issues. The degree of the relationship between internal risk and profit depends almost entirely on your ability to identify internal risks within your company and how you choose to deal with them. The more direct and efficient your approach, the weaker the relationship between profit and risk will be.

Risk only focuses on possibilities. Lessen the relationship between profit and risk by making risk management part of your everyday life. Fully insure your business to transfer as much insurable risk as you can and reduce external risks with good planning and by becoming intimately familiar with your competition. Brainstorm to identify internal risks. Then, create business rules, safety programs, credit risk management policies and quality control procedures to reduce or eliminate those you can. Finally, make use of feasibility studies that force you to look at the big picture and consider all the risks before committing time, money and business resources to an idea that may seem right but may not work in the way you originally planned.