Every business faces financial risks - there’s no way around it. Market volatility, shifting customer behaviors, and operational hiccups can threaten your bottom line if left unmanaged. A structured risk management process helps you anticipate potential challenges, take action to minimize their impact and position your business for steady, long-term growth.
Below is a practical risk management process with some tips on mitigating specific threats.
Step 1: Identify and assess your financial risks
The first step is to identify which financial risks pose the greatest threat. By examining your business through multiple lenses - credit, liquidity, market, operational, and strategic risks - you’ll gain a clearer understanding of where your biggest vulnerabilities lie. Focus on spotting vulnerabilities specific to your business and current circumstances. Are you heavily reliant on one large customer who could default? Do you have tight cash flow cycles that leave you exposed if a supplier misses a shipment? Are there weak internal controls that open the door to fraud?
Effective identification starts with sound controls and reliable data. Regularly review financial statements, track payment trends, and examine operational workflows. Tools like forecasting software and scenario planning models can reveal patterns before they become problems. A thorough assessment helps you prioritize risks so you know where to focus your mitigation efforts first.
These priorities can also shift alongside regulatory changes. For example, evolving data privacy laws - like the California Consumer Privacy Act (CCPA) and the EU’s General Data Protection Regulation (GDPR) - mean a single data breach can trigger substantial fines and damage your reputation. Recognizing this growing pressure, many companies now invest in stronger internal controls or cyber insurance early in the risk management process.
Step 2: Mitigate financial risks
Once you’ve identified and prioritized risks, choose the right mitigation strategy. Not every threat calls for the same approach, and you may need a combination of tactics to safeguard your financial health. Consider these four main avenues of mitigation:
1. Risk transfer
When a risk is significant but difficult to control on your own, transferring some or all of the exposure can make sense. This often means purchasing insurance policies that cover property damage, business interruption, liability claims, or cyber incidents.
Another form of risk transfer is outsourcing certain functions to third parties with established expertise. For example, rather than processing online payments internally and dealing with compliance headaches, you could use a reputable payment processor like Square or Bill.com. They handle the security protocols and regulatory obligations, reducing your burden.
Risk transfer is most effective when dealing with risks that are relatively common, well-understood, and insurable or manageable by specialized partners.
2. Risk avoidance
Sometimes, the most cost-effective solution is to step away from a particular activity altogether. If exploring a new international market appears too volatile or a product line consistently fails to meet profitability targets, it may be prudent to avoid that path. Risk avoidance can protect your capital and prevent you from wasting resources on ventures that don’t align with your strategic objectives. This approach works best when the potential upside doesn’t justify the ongoing vulnerability or complexity that the venture introduces.
3. Risk reduction
If a complete exit isn’t practical, lowering the likelihood or severity of the risk is often the next best option. Strengthening internal controls, like segregating duties, conducting routine audits, and updating cybersecurity measures, can significantly reduce operational or fraud-related risks.
Improving credit policies, adding supplier diversity to counter supply chain disruptions, or refining cash flow forecasting are also examples of risk reduction. This method is ideal for risks that can’t be fully escaped but can be managed through better processes, employee training, and smarter resource allocation.
For instance, consider how major retailers adapted during pandemic-related supply chain disruptions. By diversifying suppliers and using data analytics for more accurate demand forecasting, companies like WalMart and Target maintained steadier cash flow and avoided severe inventory shortages.
4. Risk retention
Not all risks can or should be transferred, avoided, or reduced. Sometimes, it’s more efficient to accept a certain level of exposure, especially if the cost of mitigating it further would outweigh the potential downside. For instance, if minor fluctuations in raw material prices are part of doing business in your industry, it might make sense to keep a small financial buffer (like a contingency fund) rather than purchasing expensive hedging instruments. Risk retention works when the impact is manageable and you’ve prepared for it. Self-insurance, for example, can handle small, routine losses without involving expensive coverage.
Examples in Action
Credit risk: slow-paying clients
If your business struggles with slow-paying clients, you might reduce the risk by implementing stricter credit terms and sending automated payment reminders to keep clients on track. Transferring risk is also an option - outsourcing receivables to a collections agency or factoring company won’t erase the underlying issue, but it shifts the administrative burden and can provide immediate liquidity. If a particular client repeatedly fails to pay, you could ultimately avoid the risk by discontinuing the relationship altogether.
Liquidity risk: tight cash flow cycles
Suppose you often face short-term cash crunches due to seasonal sales fluctuations. Reducing this risk might involve more precise cash flow forecasting and negotiating flexible payment terms with suppliers. You could transfer some exposure by securing a line of credit that smooths out cash shortages. If small, predictable dips in liquidity are simply part of your business model, you might retain that risk by keeping a modest cash reserve on hand rather than pursuing more costly financing solutions.
Market risk: fluctuating prices
If swings in commodity prices threaten your profit margins, you can reduce the risk through strategic purchasing - like locking in long-term contracts at stable rates. Some companies transfer risk by using hedging instruments or commodity futures, effectively passing price volatility to financial markets. If a certain product line proves too vulnerable to price shocks, you might avoid the risk by discontinuing it and focusing on more stable revenue streams. For minor, predictable price changes that are just a cost of doing business, retaining the risk may be the simplest route.
Operational risk: outdated accounting software
Inefficient, error-prone systems can cause financial headaches. Reduce the risk by upgrading to modern accounting software and training staff thoroughly. To transfer some of the burden, you might outsource certain bookkeeping tasks to a reliable third-party provider with stronger controls. If the complexity of certain operations doesn’t justify the effort, you might avoid that activity altogether. In less critical areas, you could accept (retain) a minimal level of inefficiency if the cost of eliminating it entirely isn’t worth the return.
Strategic risk: entering a new market
If you’re considering expansion into a region with uncertain demand, start by reducing risk: conduct in-depth market research, launch pilot programs, or partner with a local firm to gain insights. You could transfer some exposure by signing distribution agreements that put more responsibility on your partner. If the region proves too unpredictable or the costs too high, risk avoidance - staying out of that market - may be your best move. On the other hand, if you decide that moderate uncertainty is acceptable in pursuit of significant long-term gains, you might retain a controlled level of strategic risk.
People risk: high employee turnover
Frequent departures can hurt morale and productivity - plus, it costs more to find a new employee than it does to retain one. Reduce this risk by investing in professional development, creating clear career paths, and improving workplace culture to keep staff engaged. If a particular role experiences constant turnover and training is too costly, you could avoid the risk by restructuring that function or outsourcing it entirely. In some cases, you might accept a baseline level of turnover if it’s relatively low-impact or aligns with industry norms.
Monitor and adjust regularly
Risk management isn’t “set it and forget it.” As economic conditions shift, technologies evolve, and your business grows, the risk landscape changes. Regularly reviewing key risk indicators and reassessing your strategies helps ensure that your chosen mitigation techniques remain effective. Fine-tune your approaches as needed, and don’t hesitate to pivot if new information suggests a better path.
Consider outsourcing financial roles
A key way to reduce financial risks is by outsourcing critical functions, like that of your CFO. An independent, outsourced CFO brings professional oversight and objectivity to your financial operations, helping to identify vulnerabilities you might miss and offering solutions grounded in experience.
By outsourcing CFO responsibilities, you gain a third-party perspective that can help mitigate risks related to cash flow management, strategic planning, and financial forecasting. Outsourcing other functions like accounting services can further transfer risks away from your business. Partnering with specialists ensures compliance, reduces the likelihood of errors, and frees up internal resources to focus on core operations. Hood & Strong’s Client Accounting Services Group provides a full suite of outsource accounting, including CFO-level expertise, specifically designed for the not-for-profit sector.
Put risk management into action
A structured, proactive approach to financial risk management gives you more control over your company’s future. It helps you move beyond firefighting, enabling you to operate from a position of strength and foresight.
Hood & Strong is available to support you throughout the risk management process. From identifying your biggest financial vulnerabilities to helping you select and implement the right mitigation strategies, we can provide the guidance you need. Contact us for more information and recommendations.
