Effective ways to manage risk in business finance

Knowing how to manage risk in business is extremely important. In the world of business, uncertainty is a constant companion and the risks facing a business can be unpredictable in both type and impact.

Business finance can encompass everything from planning and monitoring of cash flow to controlling financial resources and achieving strategic organisational goals.

The landscape of business and finance is fraught with uncertainties, many of which cannot be controlled. Understanding how to effectively manage risk, even if it cannot be eliminated, is paramount in ensuring a company's financial health and laying out the path to a sustainable, successful future.

The balancing act of business finance

Business finance is a make-or-break aspect of a company's success. Finance covers the facilitation of daily operations, investment in critical assets and the ability of a business to respond to growth opportunities and meet market demand.

However, there is always an element of risk, even in the most well managed of business finance structures. To that end, having effective strategies to manage that risk is critical for decision making, resource allocation and operational success.

Understanding business risk

Before we can effectively manage or mitigate risk, we need to understand risk in the context of business finance. These risks incorporate anything with the potential to cause adverse outcomes that impact the financial stability or performance of a company.

Risk comes in many different forms. There is always market volatility, on both the demand and supply side, there are economic downturns at the macro level, regulatory changes from government and industry, operational inefficiencies within the business and even unforeseen catastrophes and natural disasters, pandemics included.

Not all risks can be eliminated or even mitigated, but they can all be managed, to a certain extent.

Business risk management: Can it be done?

The answer is yes, it can. But part of effective risk management in business is also appreciating what can and cannot be managed.

Market risks, for example, can be effectively managed by diversifying investments and staying abreast of market trends, technological advances and changes in consumer behaviour. Businesses with effective market risk management can weather financial storms better than those without.

Operational risks, whether employee training or technology adoption, depend on internal management strategies. This includes anything from strong management to streamlined protocols and procedures, and even built-in redundancies.

Even credit risks, through credit assessments and credit management policies, can be mitigated effectively. Whether it's through stronger payment terms or solutions such as invoice finance, minimising the risk of non-paying clients and customers can be managed, if not eliminated.

Of course, there are some risks that simply cannot be predicted, let alone managed. Natural disasters, pandemics and geopolitical risk are all external events that are out of a company's control. Financial and operational contingency plans should be in place to weather unexpected storms and mitigate the impact on the business, but as far as the risk itself is considered, there is not much that can be managed.

Similarly, regulatory changes on a governmental or even industry level are often difficult, if not impossible, to manage. While there can be some input, such as industry advocacy, there is often little that can be done in managing this risk outside of building flexibility and agility into your business's operations.

Effective risk management in business

The important aspect to realise about effective risk management in business is that it's not about eliminating all risks – or even all of a single risk – but about finding the right balance between potential reward and possible risk.

The best way to approach business risk management is:

1. 1Identify the risks and potential impacts.
2. Analyse each risk and impact as well as your business's ability to respond and mitigate each risk.
3. Prioritise the risks according to severity, likelihood and importance.
4. Design and implement strategies to either mitigate the aspects of the risk in your control or, if possible, capitalise on them.

Tips on how to manage risk in business

Comprehensive risk assessment

Regularly assess all the potential risks your business might face, considering both internal and external factors. This will ensure a more holistic and comprehensive understanding of the risk landscape and the position and strength of your business to respond.

Diversify your investments

Briefly mentioned earlier in this article, the diversification of investments is important for risk management in both business and personal finance. Reducing the impact of market volatility is impossible, but reducing the impact on your business can be done by spreading investments across different assets and markets to reduce the cost of any particular asset or market fluctuations.

Robust financial planning

Ultimately, business risk management involves significant financial planning. Considering potential scenarios and impacts and assessing a business's financial ability to adapt to those challenges can be a defining determinant in a business's capacity to continue, grow and succeed.

Insurance coverage

Investing in comprehensive insurance can help insulate a business against natural disasters, accidents, market risk and even legal liabilities. Without sufficient or correct insurance coverage, a business can be exposed to far more risk and liability than is necessary.

Internal compliance audits

Regulatory requirements and industry standards are constantly changing and being upgraded. Compliance is not about setting and forgetting, but investing time, energy and resources on an ongoing basis to ensure adherence to relevant laws and standards.

Strategic contingency planning

In a base-case scenario, your contingency plans won't be needed. But failing to prepare is preparing to fail, so putting contingencies in place will ensure your business can successfully adapt to unexpected interruptions.

Financial stress testing

Conducting stress tests on your financial models can help determine how capable your business is at withstanding changing conditions, new risks and catastrophes. It will allow you to identify areas where you need to improve risk management and develop strategies for minimising the impact of potential risks.

Continuous monitoring

Continuously monitoring the risk landscape and your internal levels of preparation will ensure that any vulnerabilities are addressed before they derail your business. Adapting new risk management strategies in response to changing circumstances will keep your business flexible and agile in the face of the unknown.

Employee training and awareness

Equipping your staff, from top executives to new graduates and apprentices, with the knowledge and skills to address potential risks in their respective roles can help mitigate many various financial risks.

Reliable and fast access to working capital is a strong strategy for risk management. Contact us for tailored financial solutions for your business. This article was originally published on ScotPac.com.au.