How to Analyze Risk in Five Easy Steps

When it comes to risk, our fears often distort our analysis. Fear of criticism, for example, may deter you from taking a chance on an opportunity.

The truth is, fear will always be with you, but by being able to properly assess risk, fear will not stop you from taking advantage of opportunities.

“When you play it too safe, you’re taking the biggest risk of your life. Time is the only wealth we’re given.” Barbara Sher

What is Risk?

Risk is the probability or threat of danger or loss.

“Never was anything great achieved without danger.” Niccolo Machiavelli

5 Reasons You Should Take More Risks

  1. Taking action will reduce your fears, give you confidence and allow you to better evaluate future risks.
  2. You will have fewer regrets in your life.
  3. Even if you fail, taking risks expands your network and brings more opportunity.
  4. Risk taking leads to creativity and innovation.
  5. You really only live once.

How to Analyze Risk in 5 Easy Steps

Acknowledging risk will make it easier for you to take more risk. Knowing what lies ahead will give you the confidence that you are looking for.

Step 1: State your dilemma

Step 2: List all the risks & gains associated with your dilemma

Step 3: What is the impact of each risk and gain?

Step 4: What is the probability of each risk and gain?

Step 5: How will you mitigate risk?

 

Example: Should I take out a business loan?

Step 1: State your dilemma

“Should I take out a business loan”

 

Step 2: List all the risks & gains associated with your dilemma

 

Risks

  1. I won’t be able to pay back the loan in time.
  2. I may mismanage the money and my business fails.
  3. The market does not respond as expected and I make less than what I projected.

 

Gains

  1. I will be able to purchase resources that will catapult my business by a projected 20%.
  2. I will not have to give up any equity.
  3. Having the money buys me time to produce an amazing product or service.

 

Step 3: What is the impact of each risk and gain?

Impact refers to what would be the effect if the risks or gains actually occurred.

Risk

In this example, the impact of each risk factor is dependent on the loan amount. If the loan is only $1,000, the impact of not being to pay back that loan is much less than a $100,000 loan.

Gain

If the loan amount is $1,000 and the potential gain is an increase of revenue by 20%, perhaps this is a positive, high impact loan. Accordingly, a million dollar loan that has the potential to create a multi-million dollar business, may also have a high impact.

However, not taking the loan may force you to bootstrap your business and grow at a manageable pace.

If I take the loan…I will be able to get much needed resources and my business has a huge potential of growing rapidly in a short period of time.

If I do not take the loan…I will be forced to bootstrap my business, but I will not have to worry about debt repayment.

 

Step 4: What is the probability of each risk and gain?

Assign each risk a number from 1-4, 1 being low probability, 4 being high probability.

Risk

  1. I won’t be able to pay back the loan in time.

The probability of not being able to pay the loan is determined by several factors:

  • Current financial state (do I have other forms of debt, e.g. credit card debt?)
  • Do I already have an existing market that is hungry for what I want to sell?
  • What assets can I sell to potentially pay the loan?
  • If my business does not take off? How long will it take to pay off the loan?
  • What are the penalties?
  • Who can bail me out?

If you already have an existing market and the loan will allow you to sell even more, then the probability is 1.

If you do not have a market and are using the money to see if you do have a market and you are risking everything to do so, then the probability is 4.

2. I may mismanage the money and my business fails.

Are you bad with your own personal finances and are an impulse buyer? If yes, your probability is 4.

3. The market does not respond as expected and I make less than what I projected.

Market research will help you determine if there is actually a market for what you are wanting to sell. Without a list of individuals who are willing to buy what you will sell or a well-defined target market, the probability for this risk occurring is high. In fact, we have a tendency to overestimate our potential revenue stream.

Step 5: How will you mitigate risk?

This is the most important section in your risk analysis. Perhaps borrowing 1 million dollars is quite risky, but if you know how to mitigate those risks, then your chances of success will dramatically increase.

  1. I won’t be able to pay back the loan in time.

Potential solutions:

  • Ask for less money
  • Assess what you can live without and save on expenses
  • Tell your friends and family about what you are doing
  • Determine what assets you can sell to pay the loan, just in case
  • Get a part-time job
  • Focus on selling your product and connecting with your market.

2. I may mismanage the money and my business fails.

  • Hire an accountant
  • Prioritize spending and focus on must-haves
  • Don’t spend frivolously

3. The market does not respond as expected and I make less than what I projected.

  • Do your market research and challenge your market to pay in advance.
  • Be realistic about your projections
  • Figure out how much it will cost you to acquire a new customer in terms of money and time

Conclusion

The biggest risk that I ever made was purchasing the domain minoritywomen.com. I will not disclose how much it cost, but I will say that there was a high opportunity cost. I could have used that money to hire staff and get other very precious resources, but I decided that the domain was a sound long-term decision.

Sometimes, taking certain risks may not be logical in the short-term, but can make a huge impact much later on. Such risks force you to succeed because you have no other choice.

When evaluating an opportunity and weighing risks, the most important question that you can ask yourself is, “Will taking this opportunity take me to where I want to be?”

 

Here are some links to open your mind to risk taking:

Big Financial Risks That Paid Off: http://www.kiplinger.com/slideshow/business/T012-S001-7-big-financial-risks-that-paid-off/index.html

8 Risky Business Investments That Paid Off Big: http://www.onlinebusinessdegree.org/2012/06/26/8-risky-business-investments-that-paid-off-big/

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