“What gets measured, gets managed.”
A quote often attributed to Peter Drucker – a well known guru of modern business management.
Nowhere is this quote more relevant than in business. While risk is an unavoidable consequence of doing business, it can be measured…and it can definitely be managed!
A business faces many different risks on a daily basis. In this article, we focus on one category of risk – financial risk.
What is financial risk?
Financial risk for a business covers anything that might negatively affect the financial viability of a company. A few examples below:
- The risk that a business will lose financial value in a public market;
- Loss of sales or potential sales
- Decrease of market share
- Employee absences leading to operations stoppages
- Theft of stock
- Wastage due to inefficiencies
- Financial risks relating to corporate transactions
We have outlined below 5 specific types of financial risk – Market Risk, Credit Risk, Liquidity Risk, Operational Risk and Compliance Risk.
We also provide some expert tips on how best to measure and manage these risks!
Risk No. 1 – Market Risk
Market risk arises from the uncertainty of the marketplace in which a business competes. The risk here usually relates to competitors securing a larger market share and your business revenues decreasing as a result.
Falling behind the market trend can often realise a market risk. This might happen due to a lack of resources, lack of operations or lack of technology. One obvious example is the emergence of e-commerce. Consumers are doing more and more shopping online instead of visiting the traditional physical store. Depending on the industry, if a bricks and mortar store cannot transition in some way to an online model, they may be at risk of losing a significant share of the market.
Check out our recent article on doing business as an e-commerce retailer in the Philippines. We discuss tax compliance for online transactions!
Risk No. 2 – Credit Risk
Credit risk relates to the potential for business clients to delay or default on their debts or financial obligations to your company. Cash is undoubtedly a crucial element of ensuring a business can continue to operate. Delayed or defaults on payments can have a serious impact on a company’s cashflow.
Depending on the size of the company, non-payment by one or two key customers might either obstruct or halt business operations. This is particularly the case where a company does not have access to a cash or credit lines to fall back on during such periods!
Credit risk is the reason why businesses tend not to offer extensive credit terms to new customers. However, after a client has sufficiently proven its ability to pay, a business can be more open to providing a credit line.
Risk No. 3 – Liquidity Risk
Liquidity is the ability of a business to quickly turn its assets into cash. The more liquid a company, the better its ability to pay off its short-term liabilities as they arise.
Short-term liabilities are debts that have to be paid within one year. Our recent article explained the key concepts of liabilities, assets and equity for a commercial business.
The liquidity risk arises where a business cannot easily convert its assets to cash. As a result, the business cannot pay its short term liabilities. Examples of assets that can be turned into cash quickly include inventories, short-term investments and collectibles.
If a company is having liquidity issues, this is a serious situation for a business – the company could be declared bankrupt if not resolved!
So make sure that the management or company accountant reviews and monitors business liquidity on an ongoing basis!
Risk No. 4 – Operational Risk
Operational risks relate to issues facing the daily operations of a business.
The operational risk arises from internal factors such as employees, systems or processes. Some sources of operational risks include:
a. Defective inventories
b. Possible lawsuits with suppliers or clients
c. Employee theft
d. Incompetent personnel
e. Equipment failures
If the above issues arise, they can have negative implications for the finances of a business. If the business is not operating or is not operating at the forecasted levels, the business will not be able to generate as much revenue as anticipated. Again, this will have a knock-on effect for cashflow.
Risk No. 5 – Compliance Risk
The risks arising from non-compliance with statutory or legal requirements. Non-compliance with rules and regulations issued by the SEC, the BIR, DOLE and other regulatory offices can often result in financial penalties for a company.
Tax filings, corporate filings, employee-related payments and contributions – these are all compliance requirements to which a business must adhere. There are many more too!
Remember – as a business grows, the compliance requirements will usually become more onerous. More employees, larger premises, new locations, additional shareholders and new markets!
The financial penalties can also increase as a business scales!
A company that is seeking to scale should always consider building a risk and compliance team to ensure that every “t” is crossed and every “i” is dotted when it comes to compliance.
For ease of reference, here are some of our recent articles that provide some helpful tips on ensuring compliance in the Philippines:
- Preservation of accounting books and records in the Philippines
- Sales invoices in the Philippines – Does your business comply?
- Mandatory payroll deductions and contributions for employers in the Philippines
- Withholding tax requirements in the Philippines
Expert tips on managing and minimizing financial risks
- In order to identify and protect against financial risks, a company should regularly perform financial risk assessments. This requires identification of all risks that may affect the business in the short, medium and long terms.
- A company should make it a habit to analyze financial statements on an ongoing basis. Here are a few things that management should assess periodically:
- Evaluate trends in each of the income statement or balance sheet items
- Identify variances between actual results with budget and forecasts
- Compare results between two different years
- Robust internal controls are key. Having identified the relevant financial risks, it is then necessary to examine if your existing internal processes and controls are sufficient to protect against these risks.
- Budgeting. This will enable management to plan ahead and provide protection against potential financial risks and shortfalls in cash. Budgeting will not only help minimize financial risks but will also play a key role in helping the business grow. Check out our previous article on why budgets and forecasts are essential for business growth.
CloudCfo can help your company protect against financial risks
CloudCfo can become your partner in growing your business. Outsourced accounting, compliance and bookkeeping in the Philippines can be much more efficient and transparent with the services of CloudCfo.
Aside from outsourcing accounting and bookkeeping services in the Philippines, you can also outsource your Chief Financial Officer. Here are 6 benefits of hiring an Outsourced Chief Financial Officer over an In-House CFO.