8 Methods to Managing Financial Risks your Business may Face
Running a business always comes with financial risks. Minimize their possible negative impacts on your organization by preparing a game plan before they happen. Get started with these 8 methods for managing financial risks.
Several factors, both internal and external, can pose financial threats to your business. Though you can’t entirely eliminate them, you can still create strategies to mitigate their risks.
Equip yourself with enough knowledge about financial risks in business through this beginner’s guide.
This article is divided into 6 sections:
Feel free to click any item above to go straight to the information you need.
Financial risks definition
Financial risks refer to any elements that could threaten your organization’s financial stability. If left unmanaged, it can negatively impact your bottom line. Worst, it can even leave you with a cash-strapped business.
Both internal and external factors can trigger financial risks, such as:
- Poor business decisions
- Lower revenues
- High reliance on a few numbers of customers
- Single source of income
- Lack of proper budget management
- Changes in the economy or political landscape
- Changes to the market interest rate
- Inability to pay your business’s debt
- Changing consumer behavior
- New competition
To keep these threats in check, you need to have effective financial risk management.
What is financial risk management?
Financial risk management is the process of evaluating and managing your entity’s exposure to financial risks. It aims to protect your financial assets through the appropriate use of resources. It also guides you in making informed decisions, especially when taking huge business risks.
By managing your financial risks and handling your funds with caution, growing your business becomes possible while minimizing the chances of incurring financial losses.
How to identify financial risks
Identifying the weak spots of your organization's financial system gives you a chance to:
- put prevention measures in place and
- prepare solutions to address them.
They serve as your Plan B when things don’t go in your favor. Instead of falling straight into the pit of dilapidated cash flow, identifying and managing your financial risks gives you a chance to take a U-turn to recovery.
So how can you do it? Check out these activities:
1. Assess your risks
Conduct a risk assessment to know the potential weaknesses and threats facing your organization. In this process, make sure to work with all stakeholders concerned, specifically your key decision-makers and accountants.
2. Analyze your financial statements
Financial statements are the key to unlocking your organization’s financial capacity. To determine any weak spots, gather your finance and accounting teams and other concerned decision-makers to review financial statements.
Identify potential threats to financial stability such as dropping revenues, potential operational weaknesses or increasing bad debts.
Related: How to Avoid Bad Debt in Business
3. Keep a look out for market trends and industry changes
External factors can have a direct impact on your cash flow. Technological developments, for instance, can influence how businesses from your industry operate. A sudden change in consumer behavior may also send you looking for alternative ways to satisfy your needs.
4. Conduct a competitive analysis
See how your competitors are doing — are they also experiencing the same financial challenges you’re facing, or is it only happening to your business? Aside from this, the competitive analysis also lets you discover new competitors and business strategies you can try out.
5. Do a scenario analysis
Scenario analysis is the process of identifying potential events, predicting their possible economic impacts and developing strategies to address their associated risks.
6 common types of financial risks
As you continue your business operations, you can stumble upon several types of financial risks. Among the most common threats are operational risks, market risks, credit risks, liquidity risks, systemic risks and legal risks. Below are the explanation and examples for each risk.
1. Operational risks
Operational risks are financial threats and hazards that occur due to internal factors like human errors, system failures, poor decisions, flawed financial reasoning, fraud and other operational issues.
2. Market risks
Market risks are external financial risks caused by market changes, fluctuations and other unforeseen events. It can have direct effects on the value of your products and services, including your investments. Some of its examples are inflation, fluctuations in interest rates and geopolitical events.
3. Credit risks
Also known as default risks, credit risks arise when your customers or clients fail to pay their dues on time or not at all. As a result, this type of risk can disrupt your business’s cash flow and slow you down from pursuing significant projects. It can also give rise to another type of financial risk called liquidity risk.
4. Liquidity risks
Whereas credit risks transpire from customers who don’t pay their dues, liquidity risks happen when you cannot meet your financial obligations like loan payments because you don’t have enough cash on hand. To mitigate it, you can either set up a line of credit or implement a stricter process to collect accounts receivable.
5. Systemic risks
Systemic risks, meanwhile, take place when an unstable business unit affects other financially stable units. If it goes unnoticed, it can threaten the financial mechanism of your entire organization.
6. Legal risks
Lastly, legal risks occur when another entity or person holds your business liable for failing to comply with regulations or contractual terms.
Managing financial risks: 8 methods to safeguard your finances
Financial risks can hinder your company from meeting its financial obligations. In the long run, they can decelerate your organization's growth and destabilize its financial system.
To maintain a healthy cash flow, here are some methods on how to manage financial risks.
1. Invest wisely
Risks associated with investments are one of the strongest and most palpable financial risks you can encounter. Luckily, there are many ways to learn the ropes to investing before giving it a final go.
Make sure to gather enough information before you make any investment decisions. In this regard, consulting with your accountant can be a great help, as they can give you sound advice on how you can maximize your returns.
2. Develop effective cash flow management strategies
Understanding how you spend cash is just as important as knowing your risks. Cash flow management — or the practice of keeping your cash flow in optimal condition — is one of the best ways to secure a financially-stable future and safeguard your bottom line from dangers.
3. Diversify your investment
Diversification is indispensable in mitigating financial risks. By spreading out your investments among different financial instruments, you can minimize their potential risks while having a fallback in case things go awry for your business.
4. Increase your revenue streams
When your business experiences a slowdown, having an alternative source of income can help you pay the bills. For instance, aside from your primary business, you can get low-risk investments or seek opportunities to get grants and subsidies from the government.
For more options, check out these 8 methods of raising money.
5. Set aside funds for emergencies
Consider saving some of your ROI in your savings account. While your savings account will not yield significant long-term interest, it is still one of the safest ways to stash your money.
Moreover, your savings account can also help you transfer cash electronically, paving the way for a quicker and more convenient financial transaction process.
6. Reduce your overhead costs
Overspending on your overhead costs — or the costs associated with your daily operations but not related to profit generation — can also be damaging to your bottom line.
By reducing your overhead costs, you can maintain your daily operations sustainably while increasing your business savings.
7. Get the right business insurance
Insurance can act as your business’s safety net, but only when you don’t overspend on premiums.
However, you also don’t want to be underinsured.
The key is to identify which type of insurance can provide the protection you need against huge financial losses from accidents, lawsuits, natural resources or other unexpected incidents.
8. Get a trusted management accountant
There’s nobody who can help you with managing your cash flow and making savvy business financial decisions better than your accountant.
Talk to your trusted and reliable accountant to help you with different facets of your business finances, be it in paying off your debts or rounding up investment returns.
Expand your organization’s risk management capacities
Financial risks are inevitable but if you know how to work your way around these risks, your business will consistently remain on solid ground.
If your internal accounting team needs support in handling your basic accounting duties while they focus on reinforcing your risk management capabilities, contact us today.
You can also get a copy of our whitepaper, Finding the Right Talents: D&V Philippines Solutions for Modern Accounting Firms, to learn how we invest in our talents’ professional growth and development so they can meet your standards and expectations.
This article was first published on 02 September 2015 and was continuously updated since then for relevancy and comprehensiveness.
Last update: 04 July 2023
Edited and updated by: Mary Milorrie Campos