Creating an effective risk-reward strategy unique to your business can be critical to long-term success.
Anyone who has owned or operated a business knows that playing it safe usually doesn’t pay off. Indeed, risk-taking is an essential skill of any successful business owner. Should you expand into a new market, add staff or acquire a competitor—or all of the above? And when is the right time to act? Nearly every business owner faces tough questions like these at some point.
So, how do you devise a risk-reward strategy for your unique circumstances? According to experts, it all comes down to visualizing the future and being prepared to act.
Strike a Balance
“Good decision-making begins with being able to envision the possible outcomes and then assigning probabilities to each,” says Steve Hancox, a consultant with Financial Resource Associates, a crisis- and business-management consulting firm. “Excellent decision makers are good at developing risk mitigation strategies, which is simply a matter of improving the odds of good outcomes and lowering the odds of bad outcomes.”
Gary Patterson, owner of FiscalDoctor Inc., a financial consulting firm that helps companies devise risk-reward strategies, says he consistently sees businesses both large and small that don’t understand how to balance risk and reward and why it’s important. “Companies can really get in a bind when they take a moderate risk for minimal reward or a big risk for moderate reward,” says Patterson. “It’s like playing craps. The odds are going to catch up with you if you take far more risks than the amount of award you’re going to get.”
Marc Glazer, CEO of Business Financial Services, a firm that helps small businesses finance expansions and other ventures, agrees that striking the right risk-reward balance is important. “The higher the risk, the less money you want to put into whatever project it is,” he says. “If you’re going to go outside your comfort zone, you want to make sure that if for some reason this other venture doesn’t succeed that it doesn’t pull the whole ship down.”
Analyze Cash Flow
Patterson advises that the first step in creating a workable risk-reward strategy is to “get more certainty on the accuracy of your cash flow projections,” followed by identifying significant issues and opportunities to determine risk and reward ratios. “Soul search like crazy about the direction of your business; it’s free. And, at least once a quarter, target a key risk-reward issue for you and then go get extra data,” he says. “If you can do a good job on how you can get money (analyzing cash flow) and knowing your company’s pluses and minuses, you can take bigger risks. But, you’ve got to always stay in balance. Don’t bet the company on one item.”
Glazer also advises companies to focus on their cash flow analysis, along with a well-thought-out plan that details what the venture is going to cost, how long it will take to bring to fruition, and the likely outcome in terms of increased revenue. “We have models that look at how they’re paying their bills today and what the additional drain will be based on borrowing money, because if the payments aren’t affordable, it’s not a good project to start with,” he says.
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Anticipate the Unexpected
Glazer adds that for any significant new venture, companies should factor in extra time and expenses so that unexpected delays or cost overruns don’t endanger the project and the company itself. “Providing that your cash flow can afford it, I would always look to have credit or a line of 20% more than your projected costs just to give yourself a buffer for unknown things,” he says. “If you don’t need it, it’s money put aside for future needs or ideas. It’s much better to be on that side of the fence than to be three quarters in and suddenly need additional funds.”