Financial Risk Management

Statistics have often shown that a significant percentage of small businesses fail in the first few years of starting operations. Inasmuch as we can all agree that the harsh economic realities in Nigeria make it difficult for businesses to thrive, poor financial risk management is also a factor responsible for the failure of these businesses.

Note that risk is a key component of life which every individual/business exposed to daily, through actions and inactions.

What is financial risk & financial risk management?

Financial risk can be defined as risks that arise as a result of how a business handles the inflows and outflows of money. It can also be described as risks that occur due to financial transactions engaged by a business although there are other factors that encompass financial risk.

Financial risk management is defined as the practice of identifying potential financial risks in advance, analysing them and taking precautionary measures to curb the business exposure to the risk.

It is worth noting that financial risk management cannot prevent all possible risks because some risks are unexpected and cannot be addressed early enough.

There are several factors that determine the financial risks of a business, 3 of them are discussed below;

  1. Macro-economic factors

How well an economy is performing will affect a business, for example, businesses are likely to be affected when a recession occurs. This is because, during a recession, there is generally a reduction in the wages of workers which will result in the weak purchasing power of customers.

This article aims to provide businesses with tips on improving their financial risk management process so as to ensure they are not just managing to survive but they ultimately grow in size and stability.

  1. External Parties

Financial risks can arise due to the actions of external parties such as suppliers, vendors, competitors, and customers.

For example, a business will suffer if a competitor discovers a technology that makes it cost effective to produce a particular product and supply to consumers, or if a business finds it difficult to collect receivables from customers as at when due.

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  1. Quality of Internal Control Policies

The above-listed factors are all external. However, what a company does internally will determine the level of financial risk exposure it will face. For example, a business where employees are not productive will result in lower output levels, lower inventory, lesser goods sold and a decrease in revenue.

So how can a business manage financial risks? Well, see some important tips below-

  1. Develop a Companywide attitude of Risk Consciousness

Financial risk management is a company wide effort and every staff must give a priority to it. Small businesses should ensure that the responsibility of ensuring that financial risks are curtailed does not lie solely with the owner of the business, every staff must develop an attitude of risk mitigation no matter how much their contribution to the business may be.

For example, every employee should have at least a basic idea of what the business is about, they don’t all have to be accountants or financial analysts, but an understanding of this will enable them appreciate how competitive the business environment is and a better appreciation of the possibility of any external threats that may hinder the growth of the business.

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Some of the things to know include;

  • The product(s) of the business.
  • The sources of the revenue of the business.
  • The uses of the company’s cash – i.e what are the things bleeding the business of cash.
  • The customers of the business.
  • The competitors of the business.

The idea behind knowing all these is that it helps employees think like the business owners themselves and this will translate to bringing ideas that will help the business move forward.

  1. Hire a Professional Financial Risk Manager (if you can afford it)

Financial risk management is a huge and daunting task; hence business owners have to be realistic about whether or not to engage the services of a Financial Risk Manager (FRM) if they can afford it.

Just the way a business employs the services of an auditor to verify the authenticity of its financial accounts at the end of a financial year, a business may engage the services of FRMs.

FRMs are professionals who have the required certification to conduct financial risk management activities. In addition, they are responsible for identifying financial risks, determination of acceptable financial risk levels, evaluation of the impact or effects of these risks and the formulation of plans and strategies to minimize them.

  1. Strengthen Accounting & Cash Control

Cash is king and every business must make more money than it spends, hence proper management of its cashflow is essential for survival.

Separation of Duties – The potential for theft or fraud usually exists when there is no separation of duties. For example, an employee who accepts cash, deposits funds, and processes other payments may be tempted to commit fraud.

Small businesses should consider setting up an audit trail with one person accepting and processing payments, and another reconciling statement.

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Management of Accounts Receivables – Small businesses should ensure they don’t have a large amount of account receivables, not all customers will pay as at when due. However, businesses can prevent cash shortage by using aging analysis and following up with customers consistently.

Invest excess cash in short term investments like Treasury Bills or place funds in high interest yielding accounts.

  1. Strengthen Internal Control Systems

Small businesses should design a set of scientific, strict, strongly operational set of a financial control mechanism as well as the accounting personnel business skills.

  1. Use Insurance as Hedge

Insurance and risk management go hand in hand. Small businesses should speak to insurance companies about what type of insurance can be purchased as a hedge against unforeseen depending on the nature of business the company is engaged in.

For example, whether a company owns or rents its office building, it is important to protect the business from fire, water, and other damage risks.

Coronation Research

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