While all businesses face internal and external risks, ranging from strategic and reputational risk, to liability, and security risk, the biggest risks facing many small- to medium-sized enterprises (SMEs) are financial. SMEs usually have smaller cash reserves and therefore need to manage financial risk across multiple dimensions of business.
Mitigating financial risks (e.g. not being able to pay back loans, goods, and services, insufficient number of buyers) and preparing for unforeseen circumstances can help you stay afloat even during challenging times. While it may seem daunting, it’s important for SMEs to learn as much as they can about financial risk management, because, as they say, “knowledge is power.”
In this post, we look at strategies small business owners can use to manage their financial risks.
Understand the Types of Potential Risks
Before you learn about the various types of risks that could have a major impact on your business and the likelihood of occurrence, it’s important to understand risk profiles. Business risk profiles determine the willingness of how much risk you’re willing to take on and how it will affect your decision-making strategy. A risk profile also encompasses the levels of risks and threats faced by an organization.
Operational risk is any internal or external risks that stem from business processes that could potentially result in loss. Operational risks can be anything from cybersecurity breaches to natural disasters – basically anything that has the ability to impact your daily operations and create loss.
Strategic risk occurs when you’re attempting to achieve strategic objectives and events occur that prevent or deter you from achieving them. Strategic risk can happen from mergers, acquisitions, other competition, market or industry changes, changes among customers or in demand, and even human resource issues.
Reputational risk can pose a threat to the survival of the big and well-run organizations, so imagine the damage it could do to a small business? Reputation risk can occur from the action of delinquent employees, the actions of the company, or even from joint venture partners or suppliers. This type of risk is damaging because it not only adversely affects an organization’s profitability and valuation, but it also impacts client relationships.
Of course, looking at internal risks such as profitability and capital management is important, but it’s crucial that you look outside of your business, for external risks as well. External risks to consider include market risk (e.g. changes in equity prices or interest rates) and what scenarios may impact your business, such as an economic downtown. These potential risks could lead to a sudden and unexpected loss of revenue.
Stay Compliant With Legal Requirements
Another type of risk is compliance related. Small business owners need to be aware of a multitude of regulations, including the General Data Protection Regulation (UK GDPR). This regulation affects any business that processes the personal data of an EU citizen (e.g. name, address, phone number, social details) and if you’re not in compliance with laws like the GDPR, you can face major financial penalties.
In addition to the GDPR, there are other regulatory requirements that small businesses need to be aware of, like the National Minimum Wage and National Living Wage and the IR35. One way businesses can keep up and comply with these regulations is by implementing proper accounting software. Proper accounting solutions will store information about your employees safely and securely in the cloud in a way that is Real Time Information compliant.
Have a Financial Risk Management Strategy in Place
Since risks are inevitable, it’s important for SMEs to have a risk management strategy in place. The benefit of identifying the risks is that these businesses will be better prepared and have more cost-effective means of dealing with them.
Start by conducting risk assessments (identifying risks). Assess the likelihood of any given risk occurring, understand the impact such a risk will have on your business, and put systems in place for dealing with potential impacts. Finally, monitor the effectiveness of your risk management processes by evaluating how well it allows you to weather those negative effects that do arise.
Risk management is important when you want to try something new (e.g. launch a new product or service) or during economic downturns, such as COVID-19 pandemic.
Be Prepared For the Unexpected
Now that you understand the types of risks that may occur, it’s important to be prepared for the unknown. One way you can be prepared financially is with good cash flow management. Cash flow is simply the flow of money coming in and going out of a business (e.g. positive cash flow means there is more money coming into the business than leaving it).
Poor cash flow is actually one of the main reasons why small businesses fail. Cash flow has numerous important roles, such as covering short-term debt, allowing you to pay upfront without using credit (this enables you to have more negotiating power), providing you with capital to seize new opportunities, creating a more valuable business, and as previously mentioned – providing the flexibility to navigate downturns.
That’s why strategic planning is crucial for building better cash flow. You can do this by preparing cash flow statements, conducting regular cash flow analyses (this gives you insight into your business), tackling delinquent payees (apply late payment fees as a deterrent), using invoice financing (get an advance on unpaid invoices), and cash flow forecasting (which gives you a better understanding of your business’ future finances).
Keep Personal and Business Funds Separate
The saying “keep your business and personal life separate” also goes for your finances. Major risk occurs when you mix your personal and business funds, including being personally vulnerable to liability, and putting your personal assets, finances, and credit history in danger.
When you keep your personal and business funds separate, it will make your and your accountant’s life easier at tax time. You’ll have more legitimacy (having a business account looks more professional), and it will help you build business credit.
There are simple ways you can keep your personal and business finances separate: opening a business bank account, getting a business credit card, setting business budgets, conducting employee training on business expenses, and keeping your personal and business receipts separate.
There’s a lot to consider when managing your business’ financial risks, including the likelihood of occurrence, types, and levels of risk, and the impact potential risks may have on your business.
Luckily, there’s a lot you can do to mitigate these risks, like knowing the types of risks (operation, strategic and reputation risk), staying compliant with legislation, having risk management processes in place, implementing good cash flow management with smart financial planning, and keeping your personal and business finances separate.
If you need help implementing some of the strategies mentioned in this article we can help. You can request a free consultation right here and we’ll to discuss your specific situation and needs.
Implementing these strategies will help you deal with potential risks that can have a major impact on your small business while you achieve your goals and objectives.