Managing financial risk

The SV Partners March 2016 Commercial Risk Outlook Report analyses more than 20 million financial records from various sources relating to Australia’s 2.34 million operating businesses.

Nationally, ASIC Insolvency Statistics indicate approximately 10,000 companies are placed into external administration each year. ASIC’s September 2015 quarter statistics indicate there was an 8.3 per cent increase in external administrations from the previous quarter.

Small businesses in particular often just want to ‘get on and do it’, so they don’t always stop to assess the risk relevant to a situation.

According to the SV Partners report, businesses operating within Australia’s retail, construction, professional, scientific and technical services, and manufacturing industries are most at risk of default within the next 12 months.

But what are the causes of high commercial risk in the private sector, and how can business owners combat the effects of financial hardship?

Risky business

Tasmania-based Yvonne Rundle GAICD, a director and chartered accountant with more than 30 years’ experience in business advisory, taxation and estate planning services, says that business owners can head into dangerous territory when they don’t take time to apply a standard risk management approach to the situation.

“Small businesses in particular often just want to ‘get on and do it’, so they don’t always stop to assess the risk relevant to a situation,” says Rundle, director of Aurora Energy and chair of their board, audit and risk committee, and chair of AGW Funds Management.

Apart from poor planning and risk assessment, Rundle lists the following key areas of risk in the private sector:

  • Ignoring reality. New business operators tend to be overly optimistic about outcomes. Start-up businesses, in particular often have a really high failure rate. Entrepreneurs tend to be optimistic about their particular business venture or idea and they don’t always counterbalance this with an understanding of what the downsides are or what the risk may be.

  • No back-up plan. What if something does go wrong? Owners generally have the strategy but no back-up if it doesn’t work out.

  • Dependency on banks. There aren’t many funding sources for small businesses outside of traditional banks. Small businesses are therefore often highly leveraged and dependent on banks to fund their enterprises. What we’re seeing at the moment is banks starting to get a little bit more conscious about their loan books. As they tighten up, they’ll start to look at who they’ve lent money to and their assessment of the businesses may cause a higher risk rating to be attached to that business than what was there previously. If revenue is declining, the banks might step in and request additional capital reductions off loan balances.

  • Difficulties in managing cash flow. It’s really hard for businesses as they grow to fund work-in-progress and inventories, and still have enough cash to manage the other areas of their business appropriately. It’s easy for business owners to get too caught up in the business rather than stand back and ask themselves, “What’s really going on here? What should we be focusing on?”

  • Lack of flexibility. When times are good in business, owners make decisions about their operations such as the number of staff required to operate, the type of benefits they provide to workers etc. However when business conditions change and revenues slow down, it can be really hard to reverse some of your earlier decisions.

Overcoming financial hardship

Rundle warns that often business owners will seek help too late.

“It’s not until they’ve experienced really dire consequences that they turn around and think, ‘I can’t do this anymore’. If they seek help a lot earlier, they can put some strategies in place to avoid or lessen adverse financial events,” she says.

Rundle provides the following guidance for business owners to combat effects of financial business hardship.

  • Education. It’s essential to have a good grounding in basic financial literacy and understand how banks and other institutions actually view your business. Increasing business owner’s education in these areas is critical.

  • Identify your key financial drivers. Once you have identified what the key financial drivers are for your business (i.e. turnover, employee productivity, lock-up time) you then need to understand how these drivers can be influenced.

  • Recruit or engage people who are complementary to your strengths. As a business owner, fully understand what your own strengths and weaknesses are and then hire people who complement you.

  • Use technology. There are a lot of products available in the market place to help businesses, many being cloud-based solutions and apps. It’s about understanding what’s out there and what can help your business. Take cloud accounting for example – a range of products are out there at the moment that can make it so much easier for a business to stay on top of their financial position.

  • Find a sounding board. To identify what is good for your business and what competitors are doing, you need to invest in networks and professionals who help you keep up with what is happening around you. A reliable, trustworthy advisor can help you make sound business decisions.