Cash Flow As Used In The Price-Cash Flow Ratio Risk Management – Some Practical Ideas on How to Minimise Risk in a Business

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Risk Management – Some Practical Ideas on How to Minimise Risk in a Business

Introduction

Risk is inherent in any business and can harm the company and even threaten its survival. Therefore, it is essential to be aware of various risks, understand their potential impact on the company and know how to manage them effectively. This article provides some practical guidance on how to reduce your risk. The discussion takes place under the following headings:

  • planning;
  • Relationships;
  • Hedging;
  • Discipline.

Planning

Detailed planning goes a long way in reducing risk. Planning should include the following:

  • Feasibility studies. It is important to determine the feasibility of a new venture with a proper feasibility study.
  • Business planning. The business plan details how, when and by whom the strategic goals will be achieved.
  • Cash flow projections. Too many businesses fail because of preventable cash flow problems. Planning the expected cash inflows and outflows and their timing is essential.
  • Financial planning. Good financial planning covers many things, including projected management accounts and basic ratios. Preventive observation and elimination of potential problems with profitability, liquidity and solvency reduces the risk of running into financial problems.
  • Project planning. Any important ad hoc project in a company is usually handled more efficiently with proper project management. This includes mergers and acquisitions, new product launches and expansion into new territories.

Relationships

When companies assess risks, they often forget the human element. This is potentially one of the most fatal risk factors. Relationships need to be nurtured. Specific relationships that are important include the following:

  • Suppliers. Good relations with suppliers are just as important as with other stakeholders in the company. It makes business sense to negotiate good credit terms with suppliers and pay them as late as possible, but once the agreement is made, the commitments must be respected.
  • Customers. Customers must always receive excellent service and be treated fairly and respectfully. A large proportion of business usually comes from existing customers. A particular bad practice is trying to make a quick profit from a customer with very high margins.
  • Employees. Companies often talk about the importance of their employees in words. Confidentiality agreements and trade restrictions can reduce some of the risk of disgruntled or dishonest staff, but they can never be as effective as a team of loyal and motivated employees.
  • Financiers. Transparency and information are essential for investors and bankers. No one likes to be blindsided or receive unpleasant surprises. It is also a good practice to provide more than promised. In tough times, financing can mean survival.
  • Second Stakeholeders. Relationships with all other stakeholders must also be maintained. This can be local government, industry governing bodies, service providers and others.

Risk protection

The essence of hedging is to avoid a possible negative effect in business with a campaign, product, etc. Hedging against risk is typical in the financial field, but with prudent work it can be achieved (to a certain extent) also at the operational level. Some of the ways to insure business operations against risk are listed below:

  • Suppliers. Having backup suppliers (especially for critical products, raw materials and services) is a good practice. This prevents the company from being bought out by an uncooperative or out-of-stock supplier.
  • Products. Every company should constantly add new products to its offer. Relying on only a few good products can be very risky.
  • Production. It makes sense to consider different production facilities (if the size of the company justifies it). This reduces business risk due to factors such as natural disasters and labor disputes.
  • Distribution. Backup storage facilities and distribution channels are recommended.
  • Customers. We have seen successful companies that had serious problems when they lost their biggest customers. Buyer risk can be significantly reduced if we have many (and loyal) customers.
  • Geography. Political or economic instability in a country can be very dangerous for companies operating there. Whenever possible, it is recommended to spread the risk over several geographical areas.
  • Seasonality. Offering products and services adapted to different seasons has a very positive effect on cash flows and minimizes the possible risks associated with it.
  • ICT. Very few businesses can survive without adequate information and communication technology. Alternative processes and off-site facilities reduce potential risk.
  • Financial. Financial risk management is widespread in large international companies. If you sell your products internationally, there are many products available to protect against various risks. The risks that need to be taken care of are currency, interest and commodity price risks.

Discipline

Discipline can reduce risks in all aspects of business. Disciplining should apply to all aspects discussed above, as well as the following:

  • Expenses. Costs need to be kept under control – especially in times of abundance.
  • Long. Debt helps a business grow. However, a company with too much debt is very vulnerable to liquidation in adverse conditions.
  • Cash flow. Lack of sufficient cash flow is a potentially fatal business risk. Cash flows must be carefully managed.
  • Growth. Business growth requires additional working capital. Uncontrolled growth can lead to financial problems and even bankruptcy and should be avoided.

Summary

Risk in business is a reality. When these risks are successfully managed, the rewards can be significant. Otherwise, the company may run into serious problems and even fail. It is unnecessary (and foolish) to ignore the risks. By following a few basic principles, these risks can be drastically reduced.

Copyright © 2008 – Wim Venter

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