The 4 Biggest Financial Threats to a Company: Identification and Management￼
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Founding and running a business can be a rewarding experience—both financially and personally. Whether it’s a side hustle or full time, your entrepreneurial venture affords you the opportunity to pursue and invest in your passions and skills.
With these potential rewards, however, comes the possibility of risk. Specifically, business risks and financial threats to a company. Running your own business, you will inevitably face situations in which the decisions you make or investments you consider will come with both benefits and risks, with the potential to affect your business greatly. This is especially true for small business owners with few to no employees to whom they can outsource financial risk management. This makes it the responsibility of you as a business owner to understand and evaluate these risks. While some can be avoided, facing risk is an inevitability for business owners and with the right approach, the harm inherent in these risks can be minimised and, consequently, benefits gained instead.
Read this blog post for an overview of the major types of financial risk for companies, as well as tips on managing risks as or before being faced with them.
Financial threats to a company in a nutshell
- Financial threats to a company are the risks inherent in every business decision you make
- Some external risks are out of your control
- Internal risks can be minimised with careful risk management
- Credit risk occurs when you loan or borrow money
- Market risk occurs when there are big changes in your industry
- Liquidity risk is inherent in your company’s cash flow
- Operational risk covers the daily activities of your business
- Identification, communication, and insurance are the most important aspects of managing financial threats to a company
- Don’t let the prevalence of risk deter you from owning a business
What are financial threats to a company?
While financial threats refers to the risks inherent in any person’s financial decisions and life, company financial threats or ‘business risk’, refers to risks strictly related to your company. Although company risk can of course have consequences for your personal life if not managed properly.
It’s important to distinguish company financial risks into two categories: internal and external.
External risks affect everybody and must be accepted as beyond your control. They are the big, potentially damaging fluctuations in the economy which no singular business owner has any control over:
- Weather (destruction of property/offices in storms, trade blockages caused by floods, fires etc.)
- Interest rates (drastic changes in interest rates on services or products affecting your pricing system)
- Exchange rates (drastic changes in exchange rates between regions due to economic instability etc.)
- Politics (sanctions, trade routes affected, political unrest in certain regions which will affect your business)
External risks like these can be accounted for, however they cannot be controlled to the same extent as internal risks. Educate yourself as best as possible by staying up to date with the economic and political situations of regions you are dealing with and considering potential weather fluctuations in areas which may affect your product transportation.
Internal risks occur within your organisation and can be controlled with more certainty than external risks. There is still an inevitability to them that must be acknowledged, but careful planning can significantly minimise the harm caused by these risks.
- Management and staff (union strikes, difficult employees, poor management and leadership, supplier issues, failure to pay or receive payments)
- Technology (outdated operating systems, increase in cost of hardware/software, failure to invest in IT staff, lengthy equipment downtime)
- Physical risk (damage of assets, lack of credit insurance, failing to hold customers accountable, credit fraud)
While many of these situations can happen by surprise and are difficult to predict, each situation has solutions that can be applied in preparation. Good communication among staff can reduce human labour problems, keeping technologies up to date and putting aside funds for IT can anticipate technological changes, and having reliable security protocol will reduce the risk of major damage to your company’s assets and reputation.
What are the 4 biggest financial threats to a company?
Further breaking down financial threats to a company means labelling and understanding the four major risks you can prepare for. Understanding these risks equips you with the prior knowledge to anticipate them, which puts you as a business owner in a good position to proceed with growing your business in a more risk-averse way.
You incur credit risk when you extend credit to customers. The risk inherent in this is the trust you extend to the customer by giving them credit, because the customer may default on the payment. Credit risk arises when, for whatever reason, the customer is unable to afford the payment they have signed up for, say through a subscription to your services.
Credit risk can also occur when you as a company borrow from a financial institution. You may find yourself in need of borrowing large sums of money at the startup stage of your company, finding investors and generating enough capital to bring your entrepreneurial venture to life. Failure to comply with loan requirements can incur serious penalties, which can be devastating at this early stage of business ownership.
A systematic risk, market risk affects entire areas rather than single businesses. For instance, any small business owner running a physical boutique shop faced market risk when online shopping grew in popularity. There is of course major profit to be made by changing with the market and culture, but failing to anticipate this change and to adapt with it risks serious financial losses and reputational harm.
Other internet-caused market changes include the proliferation of payment options, extending to cryptocurrencies and payment services—without responding to these, companies risk losing customers who have developed preferences for online payment methods if they are not offered the choice.
Market risk also encompasses your competitors. The global marketplace is increasingly competitive and businesses, no matter their size, are always trying to outdo each other with quality, efficiency, and service. For instance, if you boast fast and safe shipping of your products, expect that your competitors will take note and try to implement faster, cheaper, and safer shipping, thereby making your shipping claims redundant.
Liquidity being the level of ease with which a company asset (its products or services) can be turned into cash, liquidity risk refers to the steadiness and reliability of this cash flow, especially if a sudden need for large cash flow arrives. This sudden need might come with a damaging storm and some supplies not covered by insurance, legal trouble with an employee requiring you to hire a lawyer, or investments into new products and software.
Further breaking down liquidity risk, you get two separate types:
- Asset liquidity risk: the possibility of a lack of sufficient buyers or sellers
- Funding liquidity risk: your businesses daily cash flow operations and whether this fluctuates in a way that increases risk
Tempering liquidity risk is all about maintaining a reliable cash flow and having reserves for extreme situations.
Risk in this area refers to your daily business activities. How you manage your expenses, conduct meetings, process expenses, among many other daily activities all fall under the umbrella of operational risk. It’s good to have as many plans in place to cover potential operational risks, because although they may appear small at first, frequent and unattended operational risks can lead to serious calamities, even the collapse of your business.
For instance, you may still have to work out better communication strategies among your employees and management teams—maybe some meetings get missed, tasks go unfinished, or certain expenses are approved by team members without that authority. But because you are focusing on financial growth and believe you can neglect communication issues for the time being, you let these things go unnoticed. Their damages will accumulate in a kind of snowball effect until it is too late to do anything about them without already suffering serious consequences.
Assessing each of your company’s potential operational risks and assigning team members or blocks of time and resources to manage them will reduce risk here.
Managing financial threats to a company
Risk management will be one of your constant responsibilities as a business owner. And while there are risks inherent in every business decision and venture, there are fortunately management techniques to cover all of these financial threats to a company. Employing them takes diligence and resources, some of which will seem excessive because they are more about preventing risks that haven’t happened yet, rather than solving existing urgent problems. But the point of risk management is to reduce the damage caused by emergency problems arising, thereby maintaining a functioning and profitable business.
Identify your biggest risks
Risk identification can be overwhelming because there are so many potential risks, especially in the planning stage of entrepreneurship. It helps to break down risk identification into stages and approach it methodically, rather than writing down every possible risk that comes to mind and lapsing into a panic at the extent of it.
What are your biggest risks?
Also called ‘high level analysis’, identifying the biggest risks in your business means naming the most obvious, immediate risks that come to mind when you consider your particular area of business operations. Are they market risks (competitiveness, changing market), external risks (physical place of business, weather/environmental conditions), operational risks (employee safety, communication blockers), or others?
Optimism and confidence are important for entrepreneurs, but too much optimism becomes unrealistic, which puts you at risk. When assessing the potential risks in your business, notice if you are thinking things like ‘that won’t happen to me’ or ‘I don’t need to plan for that’ without backing up those assertions. If you can justify why a risk is so unlikely for your business that you don’t need to prepare for it, this is also a part of being realistic. Overpreparation for unlikely risks will cost you time and resources.
Communicate your risks
You should communicate your risks after you have identified the most important ones. For business owners with employees this should mean establishing a good flow of communication across management and employees that keeps particular risks under constant consideration and observation. For sole proprietorships, this will mean making sure risks are clear to clients and customers, and consulting experts on risk management wherever possible.
Discuss risks in teams
Your business may not be large enough to hire and maintain a risk management team or risk management officer. This is perfectly fine. Risk communication is about establishing protocols for dealing with and talking about risk among your staff. Ways you can do this are to develop or assign training videos on particular risks (security risks are often communicated via training videos for new employees); plan regular meetings specifically designed to discuss risk management; create or assign a role, inbox, or software feature which allows staff to quickly communicate potential threats.
Ideal for freelancers and sole proprietors who won’t have staff at their disposal, experts in their chosen fields can help you identify and manage risk. Insurance agents will help you understand which risks your company stands to face and how much you need to spend. Accountants with your financial information will assist in covering financial risks you will face and how to prepare fiscally for them. These experts will of course charge for their services, so make sure you do your own research before consulting them—make the appointment an efficient and fruitful one.
Insure yourself against risk
Once your risks are identified and communicated to the right people, it’s time to organise risk insurance. As stated above, getting the right risk insurance is a combination of your own research and consultations with experts.
In finding the right risk insurance, you will need to assess whether the risk insurance you need is required by law or because the people you are dealing with require that insurance. Public liability insurance for a market stall is an example of the latter requirement.
With insurance, you will protect many things in your business:
- Your employees
- Your assets
- Your management team
- Your customers
- Yourself and other founders
Accepting financial threats
Don’t let the presence of financial threats deter you from running your own business. Starting a business is in itself a risk, and entrepreneurs thrive on a sense of risk-taking because they want to do things their own way. Risks should be viewed as opportunities for a more successful business, given proper identification and management.
Make sure any products you sign yourself up for have optimum security standards. You as an entrepreneur deserve the highest possible protection against financial threats with your business banking apps and other software.
Hopefully this guide to risk types and advice on risk management has been a sobering reminder of the inevitability or risk, while also outlining the opportunities for you as a business owner with proper risk management.