Disclaimer: Information in the Business Financing Blog is provided for general information only, does not constitute financial advice, and does not necessarily describe Biz2Credit commercial financing products. In fact, information in the Business Financing Blog often covers financial products that Biz2Credit does not currently offer.

Only 50% of small businesses survive five years of business. It’s not hard to understand why. What often starts with just an entrepreneurial passion and a few local customers leads to growth, expansion, competition, and operational hurdles. While a 50% survival rate may be an intimidating number to face, if you’re committed, smart, and understand the risk that come your way, you can be one of the success stories.

One of the first steps toward putting your business on solid footing is creating a financial risk management strategy that helps you deal with whatever comes your way.

3 Key Takeaways

1. The top risks facing small businesses are cash flow issues, credit risks, and market volatility.
2. Small business owners can mitigate risk through finanical risk management, including smart planning, diversified revenue, and a focus on liquidity.
3. Financial risk management tools and a risk-aware culture can help you increase your chances of success.

In this article:

• Common Financial Risks for Small Businesses
• How to: Financial Risk Management
• Financial Risk Management Resources for Small Businesses
• Building a Risk-Aware Culture
• Conclusion
• FAQ

Common Financial Risks for Small Businesses

Being in business comes with inherent risk. You’ll have to deal with cash flow issues, market volatility, operational failures, and in some cases, compliance risks. Being aware of these common issues can help you prepare for them so that when a problematic situation arises, you can take action using a financial risk management strategy without suffering long-term consequences.

Cash Flow Issues

Cash flow problems can arise from a variety of sources—customers may fall behind on payments, operational costs may unexpectedly go up, or expenses may increase. When this happens, it can affect your ability to repay debt, pay employees, or purchase inventory, threatening your company’s very existence.

For example, if a large client changes from net 30 to net 45, you may not have enough cash flow to pay your employees or suppliers. Proactive cash flow management, like keeping a large cash reserve, can help solve some of these issues before they occur, and can help with debt planning strategies.

Credit Risks

Small business credit risks refer to the possibility that customers or clients won’t pay their bills at all. While late payments can disrupt your cash flow, customer defaults can be disastrous for your company’s survival. You can protect against credit risks by using credit checks before extending credit and issuing clear payment terms.

Market Risks

Economic risk in business often comes from the market. While the market is outside your control, changes that happen in the market can dramatically affect your revenue and profitability. For most companies, customer demand will shift when inflation increases, during times of recession, or when new competitors enter the market. As many as 49% small business failures happen because of market risk, according to the Commerce Institute.

It doesn’t even take a global pandemic or stock market crash to feel an impact on revenue, either. Things as simple as road construction or a city installing parking meters in front of a restaurant or other brick and mortar company can lead customers to look elsewhere. Or an increase in federal interest rates can shift buyer demand from one industry or product to another, for example, driving people to change behaviors from searching for a new house to buy, to searching for home renovation supplies.

To manage market risks, diversify your product or service offerings, stay informed about market trends, and be prepared to pivot your business strategy in response to economic changes.

Related: Emerging Trends in Business Financing

Operational Risks

Operational risks can be hard to identify, because they are often part of the status quo of your business and you may not notice the issue until it’s too late. Often, operational problems come to the forefront when a longtime staff person leaves, and a new hire uncovers unconventional workflows, or a customer is lost because a key step was missing from a process map. To mitigate operational risks, hold regular internal audits and have business continuity planning sessions to prepare for potential disruptions.

Compliance and Regulatory Risks

Unless you’re a law office, most small businesses aren’t staying on top of legal and regulatory changes. It’s enough work just trying to keep up with customer demand! Unfortunately, failing to comply with regulations can lead to costly fines, legal action, and damage to your reputation. You can keep up to date on compliance and regulatory risks by joining industry affinity groups on LinkedIn or Facebook, or by consulting with a lawyer once or twice a year.

5 Strategies for Managing Financial Risks

1. Create Robust Financial Plans: Financial risks are going to come your way, the question is, how will you prepare for them? Forecasting and budgeting are essential for planning for the future, whether it contains steady growth or some speedbumps. Make sure your forecasts are accurate by building them on top of data from past performance, then using inputs from your five year plan and strategy. Detailed financial plans also provide a roadmap for growth and can be instrumental when seeking investment or loans.
2. Diversify Revenue Streams: When you started your business, chances are, you had a single source of revenue—one product or service that landed you your first customers. But as time goes on, it’s smart to diversify your revenue through additional products and services. This way, if one revenue source runs into trouble, you can still count on cash flow from the others.
3. Maintain Liquidity: It’s tempting for small business owners to pull all the cash out of their business, either through reinvesting in the company or by making owner payouts. But if you follow this strategy, when tough times come, you’ll be in trouble. It’s better to maintain adequate liquidity so that when unexpected expenses come up, or you have revenue shortfalls, you can stay afloat. Having a line of credit or access to short-term financing can also be a valuable safety net.
4. Implement Internal Controls: When you’re in startup mode, internal processes and procedures can feel like the wild west. But as your business grows, you’ll need to implement operational risk controls. These can both help prevent error and stop fraud from happening. What does this look like? It can be as simple as clearly identifying who is responsible for each area of your business and requiring multiple approvals for major decisions, as well as incorporating regular inventory checks.
5. Stay Informed on Regulatory Changes: Since regulatory issues pose a significant risk to many businesses, staying abreast of regulatory changes. As already noted, you can join industry groups or consult with an attorney, or you may join industry newsletters. This is not an area to be passive about, as you don’t want to be caught unawares by a change in laws. Being proactive in this area can also help position you as a thought leader, potentially bringing in new business or opening up new revenue streams.

Risk Management Resources for Small Businesses

Software platforms like QuickBooks, Xero, and FreshBooks can help you track expenses, implement cash flow management techniques, and forecast financial performance. Because these tools offer real-time data and analytics, they can help you make better decisions that are backed by data. As an added perk, most offer automation tools that can save you time and reduce accounting errors.

Seeking advice from financial advisors, accountants, and consultants can provide valuable insights into managing financial risks. Professional guidance can help businesses navigate complex financial landscapes, develop robust financial strategies, and implement compliance risk mitigation. Regular consultations can also assist in identifying potential financial threats and opportunities for growth.

Staying educated on financial risk management through courses, webinars, and industry publications can enhance a business’s ability to anticipate and mitigate risks. Continuous learning ensures that business owners and managers are aware of the latest financial trends, tools, and best practices. This proactive approach to education can significantly improve a business’s resilience and adaptability in an ever-changing economic environment.

Building a Risk-Aware Culture

Educating employees on the importance of risk management fosters a culture of awareness and responsibility. Training programs can equip staff with the knowledge to identify and address potential risks, ensuring that everyone is proactively engaging in financial health monitoring.

Promoting transparency and open communication about financial health can help identify risks early. Employees should feel comfortable reporting concerns and suggesting improvements. Regular meetings and feedback sessions can create an environment where potential issues are openly discussed and swiftly addressed, contributing to overall business stability.

Conclusion

Financial risk management planning is essential for the stability and growth of small businesses. By understanding common financial risks and implementing proactive strategies, businesses can safeguard their financial health and support sustainable growth. Invest time in robust financial planning for risk management, utilize the right tools, and foster a risk-aware culture to mitigate potential threats.

FAQs

What are the most common financial risks for small businesses?

Common financial risks include cash flow issues, credit risks, market risks, operational risks, and compliance and regulatory risks. Investment risks for small businesses may also be present if you own rental property, stocks, or other investment assets. Consider using a small business risk assessment to see how much risk your company faces. Depending on your risk factors, you may also want to engage in interest rate risk management.

How can small businesses effectively manage credit risk?

Managing credit risk in small businesses can be done by conducting thorough credit checks on customers, setting clear credit terms, and regularly monitoring accounts receivable. You may also be able to use business insurance for risk management.

What tools can help in managing financial risks?

Financial management software like QuickBooks, Xero, and FreshBooks, along with professional advice from financial consultants, can help manage financial risks effectively.

How does diversifying revenue streams help manage financial risks?

Diversifying revenue streams reduces dependency on a single source, providing a buffer during economic downturns and mitigating the impact of revenue fluctuations.

Why is it important for small businesses to stay informed about regulatory changes?

Staying informed about regulatory changes helps businesses remain compliant, avoid legal penalties, and adjust operations to align with new requirements.

Frequent searches leading to this page

Financial reporting standards, how to manage financial risk in business, mitigation of financial risk, risk management finance