7 ways to reduce your financial risk
By Leon Gettler
Taking risks is part of running a business - it comes with the territory. For small-business owners, there are many things that prevent risk: developing products, manufacturing them, selling them, earning a profit on these operations and managing growth. Also, if the entrepreneur is a sole proprietor, they face additional personal liability risks and financial risks. Take the right risks, however, and you may accelerate your business growth.
Here are seven strategies that help you reduce your financial risk so you can get back to running the business.
1. Plan for potential and existing risks
Every business needs to plan ahead for future difficulties, whether they are foreseen or not. Smart business owners create an inventory of all risks ahead and then assess how the company can afford and manage them. This might also require some scenario planning - a tool developed years ago by Shell. Creating contingency plans and margins of safety are regarded as best practice for risk management.
2. Keep a lid on debt
Having a business that relies too heavily on debt, short-term and long-term, is risky. With cost pressures a constant, it leaves the business vulnerable to interest rate hikes. If you have debt, manage it. Refinance variable rate debt with a fixed rate debt which ensures future payments to your lender are more predictable. Alternatively, convert the debt into equity, giving investors a slice of the company in exchange for funds.
3. Insure against specific risks
It is important to know the specific risks the business faces and insure against them. A retail shop, for example, should insure inventory. And do you need insurance for fire, storms, breakdowns of equipment, public liability, personal accident and property damage?
4. Focus on cash
Profit is what the accountants tell you, but cash is king. Sales contribute to an accounting profit but the cash flow tells the real story. If cash receipts lag cash payments, the business suffers a short-term cash short call. In the worst case, it could be making a profit and going broke.
Cash-flow analysis manages that risk. It takes in variables such as accounts payable, receivables, costs, inventory and work in progress. Create a cash-flow forecast. The forecast should tell you who you are paying, when the payments are due, who is paying you and when that's coming in. The forecast also sets out all your costs for the month.
A good forecast model can anticipate risks so you can take action to avoid them. It can be used to develop assumptions on sales, costs, credit and funding to produce monthly cash-flow projections well ahead and assess the impact of cash flow on future sales, costs and credit terms and replacement of assets, such as office equipment and cars.
5. Have a business plan
Business plans are essential for managing risk - no small-business owner can afford to not have one. A plan goes through every step with a fine-toothed comb so you can have a better idea of when and where most of the risks are and how you can go about managing them.
6. Conduct a market analysis
To anticipate risks, analyse every trend, both current and future, in the market you intend to sell in. Research your target audience. With that information, you can then work out how you will meet their needs. Also, look at similar businesses or products that have failed and succeeded. Now plan for how you intend to stand out.
7. Don't put all your eggs in one basket
To minimise financial risk, stick to a conservative capital structure and diversify. Keep in mind that the more money you invest in any one thing, the greater the risk it represents. This holds true even if all your research indicates it is a safe bet. Spread the risk and diversify. If a risk doesn't pay off on a given project, at least you have a few back-up plans.
*This article provides general information and commentary only, and is not financial or financial product advice, and you agree not to rely upon this article in any way.