Managing and monitoring your finances and debt: Risks to your finances

• Risks need to be measured to ensure they do not exceed the overall capacity of the business. This is particularly important when long-tail liabilities and financial markets’ volatility come into play.

• Risks vary significantly in terms of reward and capital requirements; consequently, risk selection and prioritisation criteria are key to meeting business objectives.

• Risks are interconnected and may influence each other: no adequate response can be designed without understanding the full picture.

• Appropriate performance metrics and incentive systems are preconditions to healthy risk taking.

• Building generous capital buffers is not sufficient as some risk types are impossible to quantify and require a highly specialised analysis of root causes and appropriate mitigating measures.

• It is not sufficient just to assess the risks when starting a business. You need to assess them regularly so you are able to notice any newly-emerging risks and find the best ways to minimise them.

• By planning your risk responses in advance, you will be able to minimise any damage done to your business. 

• Consider hedging against your risk if your suppliers or customers use foreign currencies. For example, if you have to pay your supplier in a foreign currency in 90 days, and you suspect the currency will appreciate, you should hedge against it. If the currency does appreciate you will not lose money because you have locked in the future rate with the hedge. In the same way, if it depreciates, you will not benefit, but you will not be worse off. This option helps you to plan cash flow more effectively and is usually available as a banking product, possibly incurring a fee.

• Stress testing is essentially forecasting to model cash burn rates, cash reserves and facility headroom.

• Before testing, determine your objectives and the business case for stress testing.

• Make sure your stress testing includes both quantitative analysis and business judgement. 

• Incorporate large counterparty shocks (such as your main suppliers going out of business or your largest customer ceasing to do business with you) to evaluate the impacts of concentration.

• Do not fully rely on the stress metrics you have calculated for normal business operations when your business enters a challenging environment. In times of disruption, it is natural that your business will exceed the metrics you have planned, and trying to stay within them may provide unnecessary pressure in an already difficult situation. Monitor them only to understand how far your business is deviating from the normal time stress tests in reality. Make sure you explain this hybrid approach to stakeholders in normal times so that the steering approach you will take during challenging environments is clear to them.

• When giving your customers credit, your business takes on the credit risk associated with customer default. 

• You need to be prepared for possible defaults and make sure that your cash flow is not dependent on expected receivables. 

• It is important that businesses understand the credit risk of each customer. If a customer has a higher credit risk, they should be offered less favourable credit terms.

• Credit risk characteristics may be different depending on credit terms. Approach and assess each customer individually.

Do as much as you can to minimise the risk. To learn more about working capital and credit risk management, see here.

• Management of liquidity risks should include: 

— measurement and monitoring

— identifying assets with high levels of liquidity risk, such as land and buildings, which are usually high-valued and hard to sell in a short amount of time

— reporting 

— emergency planning for liquidity

— implementation of a stress-testing plan

— design or adjustment of models of deposit base stability (including models of stability in stressed conditions) and implementation of replication portfolios

— reviews and validations of the models and methodologies used.

• Small businesses are less likely to have a lot of liquidity in everyday business. Make sure that your business has a buffer to fall back on. Include various trigger-based moves in each scenario to prepare appropriate responses and reactions and assure stabilisation of the business.

• Identify variable and semi-variable cost elements in your cost structure.