|Risks posed by customers
|Question: Is the business highly dependent on a small number of significant customers? For example, you could have one customer who generates 65 per cent or more of total revenue, or you could have a group of five customers who collectively generate over 65 per cent of full payment. Do you have customers who take up much of your time but are less profitable than other customers?
|Risk: If the business relies on a small number of significant customers, profit and cash flow may be affected in the short term (one to six months) if one stops yielding revenue.
|ï locking in major customers through long-term service contracts, regularly visiting them, or continually asking their views about the business’s products and services ï spreading the risk by developing smaller, existing customers, so they become larger customers seeking new, profitable customers ï finding lower-cost ways of servicing the less profitable customers
|Risks posed by suppliers
|Question: Is the business highly dependent on a small number of significant suppliers? For example, do you have one supplier that provides 30 per cent or more of the total product requirements, or is there a supplier whose failure to supply could stop the business?
|Risk: If the business depends on a small number of significant suppliers, production, profits and cash flow could be affected if one fails or stops dealing with the company.
|ï locking in major suppliers through long-term service contracts ï seeking alternative suppliers capable of supplying similar items
|Risks posed by staff
|Question: Do employees see the business as a short-term employment option? For example, would they describe it as an excellent place to learn for a while or a nursery for the industry? Question: Are there employees in the business who are critical to its success? Question: Do some employees largely govern or control dealings with critical suppliers or customers? For example, some employees may manage how your business sells its goods, services, or pricing. Question: Do staff face occupational health and safety (OH&S) risks? For example, are they working in a dirty or hazardous environment, or do they have to travel extensively?
|Risk: If the business is seen as a short-term employer, high staff turnover could disrupt the business and the expense of finding and training new staff who won’t deliver a return to the business if they also leave after a short time. Risk: If an employee is critical to the business’s success, sales and profits may suffer if the employee sets up a company in competition or works for a competitor. Risk: If some employees are largely autonomous when dealing with key suppliers or customers, there is a risk of fraud or collusion, or there could be significant disruption to the business if they leave. Risk: If staff work in an unsafe environment, the business is at risk of fines and penalties and absenteeism, injury or even the death of an employee.
|ï implementing selections procedures that increase the probability of finding the right staff for the business ï putting in place confidentiality agreements and/or reasonable restraint of trade agreements signed by key staff or, where appropriate, all staff ï implementing a robust performance Development system for communication of performance expectations and goals, monitoring performance and setting remuneration ï providing ongoing training for staff consistent with the needs of the business ï allocating several people to fulfil critical tasks and provide backup in the event of illness or sudden departure ï rotating employees through various functions or departments to familiarise them with other areas of the business implementing suitable policies to minimise risks. ï using equity interests, profit-sharing or other incentives to help retain key personnel and let them share the success they create for the business. ï reviewing the period of notice required of staff who resign. Once again, be careful with this, as it could have unintended legal consequences
|Risks posed by the business premises and its location
|Question: How dependent is the business on its current location? Question: Is the business growing strongly, or is it relatively stable? If it is growing strongly, how long can this be expected to continue, and how big will the premises need to be in two, five or ten years?
|Risk: If the business depends significantly on its location to generate sales, moving to premises outside the immediate vicinity of the current location may disrupt the business by affecting customer, staff and supplier access. Another risk of being highly dependent on the premises is that in the event of a fire, flood or another disaster, the business may not be able to restart operating if the premises (including stock, equipment, materials and records) are destroyed. Risk: Unless plans have been made to expand the current premises, the business may not be able to grow to its full potential, and competitors could overtake it.
|ï identifying several suitable alternative premises which would suit customers, suppliers and staff ï where the premises suit the business’s long-term needs, consider securing a long-term lease or right of the first option when the lease expires ï managing the business to predict future space requirements early ï only businesses that are established, have good prospects and are growing should consider purchasing a property and then only if the property has sufficient capacity to allow for future expansion. Otherwise, it is preferable to rent. Renting also helps to preserve working capital for business operations
|Threats to goodwill and reputation
|Question: How exposed is the business to a threat to its reputation or goodwill? For example, what would happen if there were a product recall, if the company delivered terrible customer service or advice, or if there was a major fraud?
|Risk: If there is a large-scale product recall, fraud, or another similar event, there would be a lot of bad publicity. This could cause immediate distress to the business, including putting it to the trouble and expense of reworking. It would probably also cause longerterm damage to the business’s reputation.
|ï incorporating robust review processes and quality assurance systems to avoid a situation that may damage the business’s reputation ï investing in research and development and keeping up-to-date with technological advances ï compulsory training and development programs for staff
|Risks posed by information technology
|Question: To what extent does the business rely on information technology (IT)? Have you ever noticed how little work is done in an office when ‘the server is down, or power is temporarily disconnected? In addition, the level of risk created by using IT increases as the business becomes more reliant on it.
|Risk: If the business relies heavily on IT, it might not be able to operate without it. There are many other risk areas associated with IT, including: ï IT service delivery: do all the software applications work as intended? Are they all accurate? ï IT solution delivery: do you try integrating IT solutions into daily work processes so that the business runs more efficiently and predictably? ï IT benefits realisation: consider not only the cost of an application but also the cost of not implementing it. Some IT outlays are essential to keep pace with others in the industry
|ï protecting laptops and desktops ï keeping data safe by performing backups and storing those backups offsite ï using the internet safely ï protecting networks ï protecting servers ï securing the line of business applications ï ensuring appropriate IT support is available within an acceptable timeframe ï having an uninterrupted power supply unit ï conducting appropriate IT training for staff
|Risks posed by financial transactions: Financial transactions create risks for companies. They can be classified as liquidity, foreign exchange, interest rate, commodity price and credit risks. Each will be examined separately below. Skip any which do not apply to your business.
|Liquidity risk Question: Does the business have enough funds to pay its debts as they fall due?
|Risk: If the business does not have enough funds or is running out of money, there could be significant risks to the business and to the owner or directors who might become personally responsible for the business’s debts. If liquidity is not improved, the chances of getting a loan will be drastically reduced.
|ï managing cash flow on a daily, weekly and monthly basis by monitoring the flow of cash in and out of the business ï forecasting cash flow to identify any periods when it is not strong. Good forecasting will include ‘what if’ analysis; for example, ‘What if my sales were to drop by 5 per cent?’ ï avoid diversion of short-term funds to long-term use ï maintaining a strong relationship with a banker or financial institution to ensure they understand the business and are kept up-to-date with potential loan requirements ï monitoring market conditions to anticipate seasonal fluctuations in cash flows ï preparing aged debtor reports to monitor debtor collections (and regularly contacting the slow payers)
|Credit risk Question: Does the business sell its products or services on credit?
|Risk: If products and services are sold on credit, debtors will be unable to pay for them. This might result in either slow receipt of cash or even the need to write off bad debt.
|ï checking the credit status of the customer before making the sale ï checking publicly available documents to verify that the customer’s business is genuine and to find out who is behind the business ï be clear upfront and have suitable documentation about terms & conditions, at least email acknowledgement ï imposing credit limits to restrict your firm’s overall exposure; ï including a ‘retention of title clause for the goods you supply ï maintaining solid relationships with the debtor to ensure their current liquidity status is always known
|Foreign exchange risk Question: Does the business use foreign currency to buy raw materials or equipment or receive it from selling its products and services to overseas customers? .
|Risk: If the business does use and receive foreign currency in this way, then it is exposed to fluctuations in the value of the foreign currency, which, if not properly managed, can lead to the business making unexpected gains or losses. This risk depends on the size of transactions, the number of transactions and the length of time between ordering and paying for the goods or services.
|ï consulting your bank for assistance in managing foreign exchange exposure ï matching foreign currency revenues with foreign currency expenses through an EEFC account ï buying forward contract. ï buying or selling a foreign currency option or similar
|Interest rate risk Question: How dependent is the business on borrowed funds or income generated from interest-bearing deposits (e.g. bank accounts or investment accounts)?
|Risk: If the business is dependent on borrowed funds or income generated from savings, movements in interest rates will affect the overall profitability of the business through increases in interest expenses or reductions in revenue from interest.
|ï consulting your bank for assistance in managing interest rate exposure ï borrowing or investing at a fixed rate to provide certainty of interest expenses or income ï matching interest income against interest expense to net the exposure ï utilising available bank products that may help manage exposure
|Commodity price risk Question: Is the business buying or selling commodities a key input or output?
|Potential risk: If buying or selling commodities is an essential input or output, fluctuations in commodity prices can adversely affect the business’s financial performance.
|ï entering into fixed-price contracts with suppliers or customers ï using several financial market instruments like futures and derivatives
|Risks posed by competitors
|Question: Do competitors pose a threat to the business? For example, are competitors likely to start up nearby? Are they likely to significantly reduce their prices? Are they likely to be the first to market with a new product? Are they likely to expand their business or find new ways of getting their products to market? New online channels of engagement with customers may affect the business
|Risk: Virtually every company has competitors. However, if competitors (current and potential) pose a significant threat to the company, then the viability of the company is at risk.
|ï continuing to build on relationships with clients and the local community. Providing excellent service as a way of combating competitors! ï researching industry trends and adopting new products and services – or ways of delivering those products and services – to customers ï investing money in developing new products and services ï protecting intellectual property assets by registering them where possible (trademarks, designs, copyright, patents) ï continually monitoring competitors, including the prices they charge
|Risks posed by the market or the economy
|Question: Is the business exposed to risks from changing tastes and trends or from the impacts of an economic downturn? For example, while the company may be relatively immune from an economic downturn, a downturn may impact your customer base.
|Risk: If the business is at risk from changing tastes and trends or from an economic downturn, the viability of the business is at risk.
|ï researching consumer trends and tastes so that the business can respond to change ï continually testing the market to see what products and services consumers prefer. This provides an understanding of changing consumer sentiment during changes to the economic cycle ï promoting products and services that sell better during an economic downturn (these can be determined by testing the market) ï promoting stock or services that sell well and are profitable ï using financial statements to benchmark financial and operational performance against industry averages
|Unexpected exit of the business owner
|Question: What would happen to the business if the owner or partners died or became incapacitated? If there is no will or succession plan in place, would the business close, would it be inherited and run by someone inexperienced, or would it be sold?
|Risk: If there is no plan to deal with the death or incapacity of the business’s owner or one of the partners in a partnership, the business might have to close or be sold to a competitor to avoid putting undue pressure on the remaining owners or new owners.
|ï consulting advisers who can assist in business succession, wills and estate planning ï preparing a business succession plan and a will that is consistent with the plan ï implementing appropriate insurance that provides income or a capital sum in the event of the death or incapacity of the owner or a key employee ï where there are two or more unrelated owners in a business, consider a buy/sell agreement and funding agreement for the eventual transfer of the business ï documenting key processes and critical information so that other people can continue to run the business ï training employees so that more than one person knows how to perform each task
Other risk areas
A. Internal controls
It is essential to have controls in place to protect the business’s assets. The rules needed will vary depending on the business’s goods and funds, the industry it is in, and its potential to suffer from loss or fraud. The business’s key areas should be reviewed to ensure that policies and procedures are in place to manage risks such as those listed below.
1. Sales: What are the procedures for the delivery of goods? Are delivery instructions recorded? Could you please tell me how you ensure all sales are recorded? Also, what are the procedures for handling cash, cheque and credit sales?
2. Accounts receivable: Are outstanding payments from customers reviewed regularly? What procedures are in place to follow up on late payments? Do you know if procedures are in place to check who receives early-payment discounts?
3. Purchasing: What procedures are in place to ensure purchases are in line with what is required? Are suppliers’ details checked regularly to confirm the details (i.e. addresses or bank account numbers) are correct and not a staff member’s? What procedures are in place for checking goods received against goods ordered?
4. Accounts payable: Are payments checked to ensure they are not duplicated or identical? What procedures are in place to ensure that payment is made on agreed terms? Can rapidly increasing purchases from one supplier be identified?
5. Payments: Does the business have controls to ensure that all invoices are appropriately approved before payment? Who is authorised to make payments? Are the duties for banking and bank reconciliation separated?
One of the most important ways to protect the business against risks is to carry sufficient insurance. With insurance, you can decide which risks you must insure against and which can be covered by the company or its owners.
1. Building and contents insurance: This insurance should cover the business’s buildings, contents, and stock against loss.
2. Business interruption or loss of profit insurance: The business should be covered for disruption due to damage to property by fire or other insured perils. The cover should ensure that ongoing expenses are met, and that anticipated net profit is maintained through a provision of cash flow.
3. Public liability insurance: Public liability insurance should cover the owner and business against the financial risk of being found liable to a third party for death or injury, loss or damage of property or economic loss resulting from the business’s or the owner’s negligence.
4. Key person insurance cover: This type of insurance should help cover the loss of a key staff member.
5. Workers’ ESIC insurance: It is compulsory to maintain appropriate accident and sickness insurance for all employees you engage in your business.
6. Personal accident and illness insurance: This insurance is essential for self-employed business operators not covered by the ESIC scheme.
7. Motor vehicle insurance: It is compulsory to insure all company or business vehicles for third-party injury liability.
8. Burglary cover: Business assets should be protected against burglary by this type of insurance.
9. Professional indemnity insurance: This type of insurance is essential for businesses giving professional advice.
10. Fiduciary guarantee: Losses resulting from misappropriation by employees who embezzle or steal should be covered by this insurance.
11. Machinery breakdown insurance: This insurance should cover the business for any losses incurred if plant and machinery break down.
12. Product liability insurance: This insurance covers injury or damage caused by goods the business sells, supplies or delivers — even in the form of repairs or services. As the type and level of insurance coverage require an assessment of the business’s particular needs, it is necessary to speak to an insurance specialist to ensure your business is adequately protected.
Identifying risks and how to respond to them
Undesirable events, the probability of their occurring and their possible impact vary considerably from business to business and from industry to industry. So how does a company identify and manage these particular risks?
ï The first step is to identify the events which could cause a loss or disruption to the business.
ï Those events should then be analysed to ascertain the likelihood of their occurring and how serious the result would be if they did occur. Sta t by assessing each event as ‘very likely’, ‘moderately likely’ or ‘very unlikely. Prioritise them by putting a Rupee value on each one (e.g. the replacement cost of a critical piece of machinery; or, in the case of potential bad debts, the total value of amounts owed by customers).
ï Attend the most likely and the most expensive events first.
ï For each possible event, develop procedures commensurate with the level of risk the business is willing to accept.
- Once a procedure is put in place, it should be monitored to ensure it is appropriately implemented and is effective.