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Risk management for small businesses

This is a meeting with business leaders making decisions

“Risk,” says billionaire investor Warren Buffett, “comes from not knowing what you’re doing.” The trouble is that as a business expands, it can encounter a greater spread of risk as it outgrows the ability of the founder to know about and manage everything.

And as an enterprise grows, risk management moves into a further duty of care dimension. The business has more stakeholders such as more staff, more investors, more lenders, more customers and suppliers. That’s a lot of people who come to depend on the business and it’s not good enough for the entrepreneur to turn to them, throw up his or her hands and say ” I didn’t see it coming “I didn’t see it coming.”

Here is a short list of major risk areas and suggestions to address them:

Political risk

This one is topical right now. Who imagined, before June 2016, that the UK Government would pitch businesses into the uncertainty surrounding Brexit? Political risk is the risk that governments can change the rules and pass laws that pose threats to business. These can include things such as increased taxes, new licensing regulations, and new governance requirements.What management can do is examine the options at the earliest stage possible. Those who run the business need to get their heads together and ask the difficult questions: what if Britain does vote to leave the EU for example? What are the worst-case scenarios? How could it affect relations with customers and suppliers? Should we think about expanding our customer base and supplier roster in case they are affected? What if corporation tax rates, or fuel duty or VAT were raised? What then? And then the biggest question:

If the worst things happened would we have enough cash to weather the storm?

Maybe we should stockpile our cash as a buffer against whatever may come our way from those who make our laws, because cash is always king.

Payment risk If cash is king, then getting paid is the path to kingship.

If cash is king, then getting paid is the path to kingship.

Many small businesses are inefficient in credit checking their potential clients to make sure they have the means to pay for the goods and services they order. They are also slow to invoice customers. They can be too willing to concede credit without calculating the cash flow impact of not being paid for long periods of time, particularly by large customers. They are also slow to chase cash when invoices fall due for payment.

A lot of small businesses are over-dependent on a few clients or customers; think suppliers of automotive components to large carmakers as an example. Typically, SME’s do 80 percent of their business with 20 percent of their customers. If they have 10 customers, then 2 of them would provide four-fifths of the business revenues.

There is no reason any small business shouldn’t establish strict credit criteria before doing business with new customers unless they are in the fortunate position to trade on cash in advance or cash with order terms. Then, once sales are made, invoicing should be almost immediate and by electronic means. Someone needs to oversee tracking when payment will fall due and chase payment, even before due date, to make sure that payment will be made.

Diversifying the customer base—easier said than done—is the antidote to the 80/20 rule. Only when the worst happens do you realise how important it is to have addressed these risks. As Warren Buffett has also said “It’s only when the tide goes out that you discover who’s been swimming naked.”

Suppliers too

It is important to credit check suppliers too. The questions are…

Can we rely on these suppliers? Do they have the stability, reliability and quality of products and delivery we require?

Again the 80/20 rule applies. Many businesses are reliant on a few suppliers for most of their raw materials or services. When suppliers sneeze, their customers catch a cold.

Getting to know suppliers is as important as knowing customers. And both need monitoring regularly because their state of health can change for a host of reasons. It is when the suppliers delay deliveries, their product quality falls or customers delay payment that you need to be most wary. In the worst case, they can take you down with them.

Many more risks

If these are the main risks that threaten cash flow and therefore the health of a business, there are many more to consider.

Here are few to think about:

  • Succession: if the main mover and shaker in the business suddenly wasn’t there, what would happen to the business? Is there a succession plan in place?
  • Health and safety: what if an employee or visitor to the business is injured on the premises? What if they sue? Isn’t it better to cover the health and safety risks before someone gets hurt or the business is found to have been negligent?
  • IT risk: what if the systems that the business runs on failed? What if they were hacked? IT security is only as good as the weakest link in the systems. What is the business doing about securing its systems? What is the back-up plan to enable the business to carry on?

There are many more risks we could list. The key to risk management is making it a companywide priority. The CEO can’t know everything but he or she should be the chief risk officer. Then everyone who works in a business has useful risk management skills and insights to offer. The person on the shop floor can take responsibility for reporting and clearing up that patch of oil. The IT manager needs to be right up to speed with security. Someone needs to oversee credit checking, invoicing and chasing payment. For every risk there needs to be someone who’s thinking and doing something about controlling it.

If a business removes or at least controls the key risks to its operations as best it can, it can spend less time firefighting problems for which it hasn’t prepared. It can dedicate more time to doing the things that the enterprise was set up to do, and this must be good for all stakeholders involved.

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