How to Avoid Mismanaging Financial Business Issues & Risks
by Scott K. Schmidt, Chief Financial Officer, U.S. Money Reserve
Managing risk is about managing business. Here’s how to do it right.
Every business has potential pitfalls. Some are obvious, and others are quite subtle, even sneaky. Business, quite simply, is rife with risk. It’s important for leaders to have a good grasp of business issues and risks in order to ensure the long-term success and health of a business.
It’s also vital for leaders to recognize that risk is simply inherent in the day-to-day operation of any company. We’ve all heard the adage that there is no reward without risk — and the truth is that if someone isn’t out there pushing the envelope or developing a new tool, product, or service, business will become stagnant, and growth, profit, and long-term success will end. The end of risk-taking by companies would also have far broader implications for everything from the local to the global economy.
The moment business leaders stop taking risks is when economies stop growing. With this in mind, how do you ensure that the financial risks you take are suitable risks? How do you avoid mismanaging financial issues and risks while ensuring that your company continues to grow? Read on to find out.
Understand the Most Common Forms of Financial Business Issues and Risks
There are many types of business risks out there and many ways to break them down. In general, these can be divided into five major categories of financial risk.
The five major types of financial risks companies face are:
1. market risk
2. strategic risk
3. compliance risk
4. operational risk
5. reputational risk
A quick note about financial risks before we briefly dive into each type: Financial risks are considered separately from risks related to location or technology, though every risk listed above impacts a company’s financial well-being.
Market risk describes risk inherent to the changing business landscape and consumer desires. For example, consumers have increasingly moved their purchasing power online over the last two years, thanks to COVID and the global pandemic. Many brick-and-mortar stores have had to quickly shift to online sales to remain open. Most economists don’t expect that trend to shift back to brick-and-mortar shopping anytime soon, either. This means that companies will have to continue to innovate around ways to deliver and market goods to customers who have cut back on how frequently they head to brick-and-mortar stores.
Market risk also encompasses issues like innovation. Every company continually tries to innovate around their product, service, or offering to gain a competitive edge over other businesses in their specific sector. If your company ceases to innovate, a competitor will likely take advantage of that shortcoming and potentially win over some of your clients and customers as a result. To be financially secure and successful, your company has to intelligently innovate around what you offer, how you offer it, and who you target. Your company has to strike a delicate balance when managing innovation and market risk. It takes plenty of insight, patience, and understanding many factors to manage well.
When a company doesn’t operate according to its business model, its strategy becomes less effective over time, and it may struggle to reach its defined goals. Strategic risk arises when a business does not operate according to its business model or plan. Strategic risk and market risk can be closely related and intertwined.
Strategic risk also includes factors such as war, climate change, sudden weather events, supply chain disruption, and natural disasters. All these elements can impact the markets for various products. For example, used cars are costly right now because of the chip shortage that is crimping the supply of new cars. The demand for vehicles has largely remained the same, but because of the shortage of both new and used cars, the automotive market as a whole is booming, with new and used cars going for well over sticker price in some cases. As a reminder, a financial business issue or risk doesn’t always yield a negative outcome.
The third form of business risk is referred to as compliance risk. Compliance risk primarily arises in industries and sectors that are highly regulated, like alcohol, banking, and healthcare. Compliance risk arises when a brand fails to understand the individual requirements of its operating location. Companies can run afoul of federal, national, state, and even local laws depending on what kind of business they run. When a brand or company is noncompliant with any laws, the financial consequences can be tremendous. Compliance risk is often best managed by a compliance officer with plenty of experience in the space so they can help you navigate the ever-changing world of laws and regulations in your business area.
The fourth type of business risk is operational risk. This risk arises from within the corporation, especially when the day-to-day operations of a company fail to perform. That failure could be because of an outsize credit risk, which is multifaceted, or even a liquidity risk. Operational risk also includes everything from lawsuits to personnel issues, business model risk, and fraud risk. These kinds of risks vary based on what kind of business you are in. Some business models are riskier than others.
One key operational risk that is strictly a financial risk is credit risk. Credit risk can refer to the risk that companies take on when they offer credit to their customers. It can also refer to the risk that companies take on when they take credit from suppliers. On both sides of the equation, the company takes on default risk. Whether your company defaults on a loan (which negatively impacts the company’s credit rating and ability to borrow more in the future) or a client defaults on credit that your company has extended (which means your company is left holding the bag), both situations negatively affect your company and can put it at a significant disadvantage both financially and competitively.
Cash flow is ultimately at the heart of this equation, and understanding cash flow is vital to lessening company risk and making sure a company has enough cash flow to both manage its own risk and pay its obligations. Managing cash flow is key to maintaining a healthy and sustainable business.
Another key financial business issue and risk that falls under operational risk is liquidity risk. When we talk about liquidity risk, we’re really talking about how quickly and easily a company can convert assets (like equipment or goods) to cash, should there be a sudden cash-flow issue. Many companies are subject to fluctuations in cash flow. Some businesses are seasonal and have to make enough money during the booming season to cover the lean seasons.
When dealing with liquidity risk, you’ll likely hear a lot about free cash flow. That’s because investors look at metrics that represent free cash flow to decide whether a business is a good investment or not. Managing cash flow is key to keeping your company humming on all cylinders.
Most of us inherently understand reputational risk. Any time a company’s reputation is compromised, either by an event resulting from a previous business risk or by a different occurrence, the company runs the risk of losing customers and significantly reducing customer loyalty.
Reputational risk can come in all kinds of guises. These risks can be the result of any number of missteps. Some examples include making a bad supplier choice (a supplier that pollutes the environment) or creating a faulty product (e.g., exploding cell phone batteries). In either case, the company’s reputation can and does take a hit, meaning fewer people will purchase the company’s goods or services. If that reputational hit lasts long enough, it can force a business to close or file for bankruptcy.
How to Avoid Mismanaging Financial Business Issues and Risks
Knowledge is the best tool to mitigate the mismanagement of financial business issues and risks. While no one can know everything, it pays to gather as much information about your business and what potential pitfalls might snag your business in one of the ways discussed above. Getting an idea of what kinds of business and financial risks you may face as you run your company is a vital first step to managing your risks.
So let’s talk about how best to manage these kinds of risks. Since each business and sector can vary widely, it’s really important to understand the ins and outs of your specific business. Just knowing what you are working with makes a tremendous difference in managing risk. And there are still a few other essential tips and tools to employ to avoid mismanaging your financial business issues and risk.
Prioritize the Right Risks for Your Company.
Every company is different, everyone faces different levels of risk, and every company has a different level of risk tolerance. Those risks and risk tolerances differ based on what exactly your company does, where you operate, and how you do business. It’s important to have a good grasp of just how risk-tolerant your company is and know where you are most exposed to various risks.
When managing risk in any company, the key is to recognize and prioritize significant issues that could potentially come up and impact your business, specifically your bottom line, or your ability to meet specific financial metrics your company may have.
Here are some questions to help you identify these risks:
- How likely is it that this particular risk will impact my company?
- How exposed is my company to this risk?
- What steps can I take to mitigate or even eliminate the biggest risks?
By using these kinds of questions to help you identify and prioritize your risk exposure, you will be better suited to manage financial risks and make better decisions that can ensure the longevity of your company well into the future.
Mitigate the Highest Risks With Smart Management.
Once you’ve identified the issues that pose the greatest danger to your company, you need to figure out a way to mitigate those risks, a strategy that works for your business.
The tools you use to mitigate risk will look different based on your company and your situation. Perhaps mitigating risk for your company means buying the proper insurance so you are less exposed to potential problems. It may mean having stricter protocols to ensure that you are not making bad investments or pursuing products that don’t make sense for your customers or your clients. It may also mean that you choose to roll back any exposure you may have to clients, customers, events, or other situations that have become riskier than you like.
Risk evaluation is a constant process. With new information coming in every day (supply chains, political shifts, the potential for war, etc.), it’s vital for leaders to constantly assess the risks their company faces. Financial risks can (and do) change and evolve over time. As the economy changes, as the pandemic peters out, as the potential for war looms, and as world politics change, it’s essential to continually evaluate the risks you have taken on and make sure you are still within comfortable bounds for the current moment. This is a really delicate balancing act in many ways, and it can take a lot of time and resources, but it’s well worth the investment to ensure the security of your business in the long term.
Growth is great, right? It depends. There is, after all, the possibility of overextending your business (and yourself). Overextending or growing too fast can profoundly impact your risk exposure and put you at a disadvantage relative to the market, your competitors, and your business goals. Expanding too quickly can deplete valuable resources, overextend your credit, and put you at risk.
The key when it comes to managing growth is to balance the risk of expansion with the reward of gaining new customers, creating new products, or offering new features.
Again, this looks very different for every company. Much of the blueprint for determining how best to manage growth relies on the sector you participate in, what your competitors are doing or developing, what your consumers want, and where the market for your good, product, or service might be headed. You’ll need to weigh several factors when you think about managing growth, but a good place to start is to consider how heavily you rely on technological innovation or general ideation for growth. If your company is on the bleeding edge of innovation, relying heavily on the next great tech improvement can become more and more challenging. Managing growth in an intelligent way is key.
Build and Keep the Right Team.
Part of the trick to avoiding financial business issues and risks is having the right team to help you manage those risks. No one person can see all the problems or exposures that could potentially derail your business. Having a diverse group of reliable, trustworthy associates and even outside experts can help you properly manage risk exposure and keep your company on track.
The value of having a diverse group of people to advise you on risk cannot be overstated, which is why it’s so vital to ensure that you not only build the right team, but also offer them the very best package you can to keep them. The value of diverse voices can’t be understated. Different people see things from different perspectives and bring a variety of different voices and experiences to the table. That can be incredibly valuable when trying to innovate and stay ahead of your competitors. It can also be extremely valuable when taking on new risks, expanding your footprint, or offering a new product. Getting and keeping the right team in place is vital to ensure that you are not overexposed to risks.
The Bottom Line on How to Avoid Mismanaging Financial Business Issues & Risks
At the end of the day, managing risk comes down to knowing and understanding your own limits and those of your business, employees, and company. Keeping realistic tabs on the five main types of risk your company may be exposed to and knowing which levers to pull to keep your company safe is also crucial.
Each business has different exposure to financial risk. Depending on what kind of business you run, you may have other avenues to protect yourself that I have not discussed here. The best way to prevent mismanagement of financial business issues and risks is to prioritize your exposures, mitigate those top exposures as best you can through insurance or other financial tools, intelligently manage your growth and innovation, and build and maintain the right team to support your goals. If you follow these tips, you’ll be sure to build a successful business that will last well into the future.