How businesses can use stress testing to improve risk management
March 30, 2023
If you’ve been following the news lately, you’ve surely heard or read about the sudden rise in concern about the banking industry. Although the story is still unfolding, an important lesson for business owners is already clear: You’ve got to be constantly on guard against the many risks to your company’s financial solvency.
One way that banks are advised to guard against catastrophic failure is to regularly perform “stress testing.” Doing so entails using various analytical techniques to determine whether and how the institution would be affected by specified financial developments or events.
But this advice isn’t necessarily restricted to banks. Businesses can use stress testing as well to get a better sense of how they should respond to a given threat.
Identify major risks
To get started on a basic stress-testing initiative, you’ll generally need to identify four types of risk to your company:
1. Operational risks, which cover the day-to-day workings of the business and can include dealing with the impact of a disaster arising from natural causes, human error or intentional wrongdoing,
2. Financial risks, which involve how the company manages its finances and protects itself from fraud,
3. Compliance risks, which relate to issues that might attract the attention of government regulators, and
4. Strategic risks, which refer to the business’s grasp of its own market as well as its ability to respond to changes in customer preferences.
When examining threats in each category, be as specific as possible. No detail or technicality is too small to factor into your assessment.
Meet with your team
Once you’ve identified the pertinent risks in each category, meet with your leadership team and professional advisors to improve your collective understanding of each threat. Even more important, discuss the anticipated financial impact of the identified risks and your company’s ability to absorb or adjust to the projected negative effects.
The ultimate objective is to develop a game plan to mitigate every identified risk. For example, if your business operates in an area prone to natural disasters, such as earthquakes or wildfires, you obviously need an evacuation and disaster recovery plan in place.
But other situations aren’t so obvious. For instance, if your company relies heavily on a key person, you should develop a viable succession plan and consider buying insurance in case that person unexpectedly dies or becomes disabled.
Focus on continuous improvement
Risk management is a continuous improvement process. New threats may emerge, old ones may fade — and even the best-laid plans tend go awry when left untended. Meet with your leadership team at least annually to conduct stress testing and assess the most current threats to your company. Contact us for help gathering and organizing relevant financial data and developing accurate projections.