A fresh perspective on risk
How to use words, not just numbers, to make better business decisions.
Suppose you have an opportunity to buy a business in town. The prospective seller has provided a set of squeaky-clean financial statements. Based on the financial ratios worked up by your accountant, the price seems fair. Are you good to go?
In Ted Darling’s view, at this point you’re only halfway to making a good decision. Even if the quantitative issues check out nicely, you should still consider the qualitative side of things.
“A lot of us are familiar with financial risk management,” says Darling, Business Risk Management Specialist with Alberta Agriculture and Food in Airdrie. “We take comfort in numbers because there is a whole set of tools we’ve grown up with, like financial statements and ratios, that are based on hard data. That perspective is very important, and financial professionals are great at providing it. But the numbers can only take you so far.”
Different sides of risk
Darling sees several issues with the conventional risk management approach to decision making. One is the definition of risk itself. He defines risk as the possibility of an unforeseen outcome, rather than simply the prospect of a damaging outcome.
“We often take steps to eliminate the possibility of a negative outcome,” says Darling. “However, doing so also often eliminates the possibility of a positive outcome. We should look at risk as being both negative and positive, and treat the two in a more balanced way.”
He notes that past performance isn’t always a good predictor of future performance. What’s more, circumstances can change so fast that an apparent apples-to-apples comparison likely contains an unknowable number of oranges. In the end, even when the numbers aren’t supportive, people will sometimes take the plunge anyway. “It’s human nature,” says Darling. “We’re wired for optimism.”
Finally, what about those issues that seem to defy traditional financial analysis? Changing consumer tastes. Political developments. Human resource issues. Can these be considered with as much care as the financial picture?
Risk discovery with words
To help bring the qualitative to the table, Darling developed RiskChoices, a decision matrix tool that uses common sense language to identify and manage risk. Using an instruction folder, worksheets and charts, RiskChoices allows users to consider risk in terms of likelihood (what are the chances this could happen?) and impact (if it did, how good or bad would it be?).
Once risky events are identified, analyzed and ranked by likelihood and impact, users can find ways to mitigate the risk. In the case of the business-in-town investment decision, for example, the buyer could request that the seller stay on staff for the first year of new ownership. The buyer could also choose to buy a controlling, but not sole, share of the business.
Darling believes that RiskChoices can be helpful for virtually any kind of business issue. Used in tandem with financial due diligence, this approach can form the basis for well-rounded farm decision making.
To get started, visit Alberta Agriculture and Food’s website at www.agric.gov.ab.ca. In the search box, enter RiskChoices.
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