If you are talking about an individual level, the financial risk is the probability of a person falling below the minimum standard of living. It is the risk associated with the consequences of an adverse financial outcome. When it comes to financial risk in business, it’s the probability of facing bankruptcy. Aside from nature’s work, this usually happens when you don’t have a proper cash flow forecast, or due to impulsive spending. In fact, only 10% of the startups in the US thrived last 2019, as featured in Investopedia. Business owners confessed that one of the top reasons for this was poor financial planning. When things got rough during the early days, they didn’t have the finances to sustain a contingency. To prevent your company from being on the brink of collapse, you need to be fully aware of the ways how to reduce financial risk.
Company-Specific Risk and Sector-Specific Risk
If a company is risk-averse, it’s willing to avoid risk and not take the chance of losing money. Several factors contribute to financial risk. The factors can be divided into two broad categories: company-specific risk and sector-specific risk.
What are Company-Specific Risks?
The company-specific risks pertain to business risk, financial risk, and operational risk. Your business becomes at risk when new emerging technologies, for example, could make your services irrelevant. Any threat to your business, from competitors to technology, exposes your income to risks.
Unlike business risk, financial risk happens internally and has nothing to do with your competitors. This happens due to calamities, fire, employee accidents during working hours, or poor credit risk management. In cases like this, a backup plan can help.
Moving forward, operational risks have something to do with the human resource management and infrastructures to operate. Poor productivity and quality control, and even failure to export crucial data for backup trigger operational risks. You become prone to this risk if you don’t have a reliable cash flow system. With a cash flow forecast application, you can keep track of your financial standing and ensure that you are constantly growing your revenue. A forecasted cash flow will help you set the gross sales you need, and distribute the number of high-quality products necessary in getting your target net profit.
What is a Sector-Specific Risk?
Sector-specific risk, on the other hand, refers to your risk of losing customers due to the crashed market value of your industry. An example of this would be the fall of tourism during the lockdown. The travel and tourism sectors could no longer operate while Tiktok reached its peak along with digital media influencers.
The specifics mentioned above expose businesses to fatal risks. Although hazards are inevitable in some instances, you can still reduce the risk of bankruptcy or losing everything. You might not be able to control the low-pressure areas that create storms, but you can plot contingency plans you can use when things don’t turn out to be in your favor.
Ways to Reduce Financial Risk in Business
Build a Valuable Skill Set
What are the things you do best? How can you use them to expand your business? It is indeed necessary for a leader to be well-informed about each business function. However, having skill sets that are not dissolvable by future technology will keep your organization functional despite the threats that will come along.
It is always better to have a specialized area so when the time comes, you’ll be confident to invest more in things you have a deep understanding about. If you have built strengths in digital product creation, you’ll be confident your company can also pivot into a new product line. If you’re wondering how to reduce financial risk the best way, have an area of expertise that you can confidently optimize anytime. In case your current products crash their market value, you can easily venture into a new business and outsource the necessary tasks to a talented workforce.
Set an Emergency Fund
If your personal emergency fund should be able to support your 6-month expenses, the same should also go for a business emergency fund. With business, you can prepare an emergency fund that can keep you operating for up to 12 months. This should be able to support you on your revamp while you use your master skill sets in creating more revenue for the company.
Don’t Put All Your Money in One Place
As the old saying goes, putting all your eggs in one basket also means a high probability of losing them all when your basket falls. The same logic applies to your business investments. The best thing to do with the profit you get is to diversify it into multiple stocks, rather than pouring it all back into your operations. If asset allocation is not one of your strengths, reduce investment risk by delegating this critical task to an investment portfolio manager.
Have a SWOT Analysis In Place
If you are planning a new business venture, you might want to consider performing a SWOT analysis. It stands for Strengths, Weaknesses, Opportunities, and Threats. This analysis is meant to be a self-assessment of a business and its goals. Here is a breakdown of what a SWOT analysis entails. A business’s strengths and weaknesses are internal factors, meaning they are things that you have control over. These give you a more thorough understanding of the business environment. Strengths and weaknesses directly relate to what you can do and what you can’t do with the business. On the other hand, opportunities and threats are external factors you don’t have control over. However, you can identify the possible ones early on and prepare a contingency plan for each. Brainstorm and talk about this with your business executives. You can always seek a second opinion from a market risk manager too.
Invest in a Business Insurance
If you want to make a big name in the industry, let others handle the risks in exchange for a lesser lump sum amount. If your business burns down, everything you have worked for is gone. Your insurance would cover the costs of rebuilding a new business along with the resources you have already invested in. If you do not have insurance and something happens to your business, you could lose everything. It is better to be safe and protected.
Business insurance can be a complicated thing. It can take years for even the most dedicated business owner to master the intricacies of insurance policies. After all, there is a lot to learn. You have to know what types of risks your business faces, which types of insurance offer the best protection, and which types of insurance you need to have. For your best benefit, seek advice from legal professionals first and let them review the legitimacy of the insurance you’ll be getting.
Keep Only the Good Debts
Every financial executive knows that the rich don’t use their personal money when they get into a new business venture. Even some of New York’s elite had this notion when they approved the loan of Sorokin, who proclaimed herself to be a German heiress.
Sorokin’s case was one in a million. You, on the other hand, have all the opportunities to secure business loans with a high credit score. Thus, just like the game of Monopoly Deal, save the best cards for the winning assets and better deals on the table later on. Only secure a loan for high-value assets such as a well-researched company project, or A-Players that will make a high-value team for your business.
Conclusion
No matter how inevitable business risks are, there will always be ways to outsmart them whenever they decide to show up. Learning this cheat sheet on how to reduce financial risk is a great start.
