Business owners have been bombarded with unprecedented risks over the past few years. COVID-19 wreaked havoc on many operations, and the resulting supply chain issues and staffing shortages caused some businesses to close up shop.
Persistent inflation has caused consumers to tighten their belts and put businesses under immense pressure. High interest rates have made using debt a risky proposition, leaving some companies without a way to reach their objectives.
An ironclad risk management plan is more important now than ever. Financial risk management is designed to protect a company from those types of risks and to mitigate those threats that could derail a company's mission.
Some financial risk management strategies are considered a given. Insurance coverage for if someone gets injured on your property may not only be a best practice, it could be required by law. But there are so many other risks that businesses face, and each requires a unique solution.
What are the types of financial risks?
While the pandemic was (hopefully) a once-in-a-lifetime event, businesses face financial risks every day their doors are open. Those risks are market risk, credit risk, liquidity risk, and operational risk.
Market Risk
Businesses are just as vulnerable to market whims as individuals. Maybe more so, because many companies invest at a higher scale. Diversification is critical, and hedging your investments will make sure your business doesn't take a critical hit from a bad investment.
Market risk also includes interest rates, and high rates mean the cost of incurring debt skyrockets. Exchange rates are a risk factor for companies that operate globally because fluctuating currency values can affect your bottom line. Inflation may be the most important market risk because the rising cost of doing business should always be top-of-mind.
Credit Risk
If you lend money, you might not get paid back. Certainly, companies that offer loans or mortgages are well aware of the risk of default. However, any organization that offers credit to its customers is at risk of not being paid back. Credit risk is when your business overextends itself to its customers.
Liquidity Risk
On the other hand, you could be a credit risk to your lenders if you don't have the ability to pay your loans. Liquidity risk is when you don't have the cash on hand to pay your debt obligations or to meet your short-term expenses.
Operational Risk
The risk of internal error exists in every operation. Especially in businesses using outdated accounting methods, the chance that something gets misfiled or lost could add up to a substantial financial risk. Operational risk is when someone or something inside your operation causes a negative financial outcome.
How can those risks be mitigated?
There are many types of risk, and there is no one-size-fits-all solution to tackle them. However, there are proven strategies that businesses use to combat risk.
Risk Avoidance
Avoiding risk altogether isn't possible, but sometimes there's a fork in the road. If one path is too risky, you could avoid it entirely. You could decide not to proceed with an acquisition that could expand your customer base if its cost puts too much short-term strain on your company.
Risk Reduction
Avoiding risk may not always be feasible, but businesses are constantly trying to reduce risk. Working to lower expenses or diversifying your portfolio are tried-and-true ways that organizations use to reduce risks.
Risk Transfer
Another risk mitigation strategy is to divert risk to a third party. The third party could be the insurance company that covers your fleet of company cars. It could also be an outsourced expert who handles a critical project you aren't able to complete internally.
Risk Retention
Sometimes companies have no way to mitigate or avoid a risk and just have to deal with it. Inflation isn't something you can change, but it's something you can plan for. If your supplier raises the cost of their products, for example, you may have to accept it and look to cut costs elsewhere.
How does insurance help manage financial risks?
Insurance is one of the most common ways to minimize risk. As an individual, health insurance is designed to keep an unexpected medical bill from crippling you financially. Auto insurance should handle those costly repairs in the case of an accident.
Injuries and accidents that happen at work should be covered as well. Insurance can also protect you should a customer claim that your product is defective or has caused them harm. Insurance premiums can be costly, but it's a necessary part of a holistic risk management plan.
How do I evaluate my risk management protocols?
Creating that plan (and sticking to it) is a struggle for every business, but there are defined actions you can take. The first step is to identify the potential risks your business faces. Next, you'll assess each risk to see how likely it is to occur and what financial consequences it could cause.
Then it's time to implement risk controls. This could be a policy change to mitigate operational risk. It could be upgrading your insurance plan. It could also be selling off concentrated investments and hedging with ETFs or bonds.
Next, you have to monitor each risk response to see if the controls you implemented are sufficient. If not, you'll have to assess the risk again and implement a new risk control plan. Constant stress testing is necessary to ensure that your company's Enterprise Risk Management (ERM) plan is fully maximized.
How do I keep my risk management systems up to date?
Creating and maintaining ERM solutions takes time, and that's in short supply for many business leaders. That's why many organizations outsource financial risk management. A third party can analyze your business entirely and root out weaknesses and threats.
If your ERM plans aren't up to par and you're concerned about financial risks, contact us now. Multiview Financial Software's cutting-edge financial management tools can identify the risks your business faces and make sure you've maximized your return.
