Financial Risk Management: Small Business Advice from a CFO

Fractional CFOs view the world through two lenses: risk and reward. Business owners focus mainly on reward (profit), which is easy to measure, while tragically few entrepreneurs look back on a month with low profits and say, “well, at least we managed our risks properly.”

Despite the general preference to focus on profits, financial risk management is crucial to long-term success. In fact, most unprofitable months could have been avoided through basic risk mitigation, such as creating a financial forecast, performing a sensitivity analysis, and developing a financial strategy.

Here’s one piece of universal small business advice to all business owners: invest equal time in financial risk management as growth planning.

There are hundreds of risks faced by small businesses, but there are six major risk categories that should be managed to avoid growth disruptions:

1. Sales risk
2. Unplanned expenses
3. Supplier risk
4. Competitive risk
5. Capital risk
6. Employee churn risk

Sales Risk Management

Disruptions to revenue are the most common cause of small business failures and thus deserve significant risk mitigation effort. Anything that unexpectedly decreases revenue falls into this category of risk, including:

• Losing one large customer
• A sudden increase in customer returns
• Failing to close a large prospective customer
• Losing a key salesperson

Risk mitigation starts with contingency planning. What would you do if you lost your largest customer? Or your key sales person? Answer these and other key questions once per quarter to ensure you know all your options.

Early detection is also critical for sales risk management. Routine reporting of close rates, return rates, and customer satisfaction keeps your team abreast of brewing issues. Weekly KPI reporting is an excellent way to detect sales risks early. 

Once your small business has experienced a sales disruption, you need to respond quickly and appropriately. A significant decrease in revenue can result in layoffs or restructuring. For more information, check out our article on what is a business turnaround.

Unplanned Expense Management 

Large unplanned expenses are never fun, but most businesses have experience managing such surprises. Unplanned expenses risk includes events such as:

• Fraud and embezzlement
• Natural disasters
• Lawsuits
• Hacker security breaches

Most unplanned expenses can and should be managed through business insurance. Work with a broker to ensure you have sufficient coverage from a reputable firm. 

You can also avoid unpleasant legal issues by only signing contracts vetted by legal professionals. Make sure your client engagements are protected by strong terms and conditions.

Supplier Risk Management

Just like internal defects and downtime, supplier quality and timeliness can jeopardize your cash flow and profitability. In fact, supplier defects can be more challenging to detect than internal errors, and supplier delays more difficult to resolve. 

Large corporations have Supply Chain Management professionals dedicated to supplier risk and performance optimization. Your small business likely cannot afford such an expert, but you can lean on their best practices:

1. Supplier approval process. Establish a systematic approach to vetting and approving suppliers that meet your quality standards.
2. Diversification. Whenever possible, ensure each raw material or component can be purchased from more than one supplier. This avoids critical dependence on one vendor.
3. Collaboration. Work intimately with critical suppliers on delivery timing, quality issues, and disruptions. Weekly phone calls with the supplier are best.
4. Integration. For mission-critical raw ingredients, consider vertically integrating them into your business.

Competitive Risk Management 

Your marketing department’s full-time job is monitoring and beating competitors to win your target customer. One piece of small business advice is that even if you do not have a marketing professional, these tasks should never be ignored. Instead, they should be carried out by the business owner or a key salesperson. Competitive risk takes many forms, including:

• Pricing wars, discounts, and other market-share grabs
• Development of superior competitive products
• Reframing your marketplace through a shift in narrative or ideology
• Character and reputation attacks

Managing competitive risk requires investment in three key pillars:

1. Comprehensive market research. Frequently speak directly with customers, competitors, and suppliers to remain appraised of changes in your marketplace.
2. Clear brand strategy. Have a well-defined marketing strategy and deploy it strongly and consistently across your chosen channels. Don’t leave room for ambiguity or misinterpretation.
3. Research and Development. Stay one step ahead of the competition by continuously improving your product or services. 

Capital Risk Management

The capital markets create different pressures on different businesses based on their exposure to debt, venture capital, or private equity. In general, the higher interest rates are, the more challenges from capital. 

The three ways to manage capital risk are:

• Minimize debt. Less debt means less interest rate exposure. As a downside, less debt means lower return on equity for owners, so consider debt levels carefully when developing your financial strategy.

• Cash flow positive. A business generating positive cash flow does not require outside capital, leaving managers free to focus on growth.

• Long exit-horizon. Capital markets influence your ability to sell the business. By maintaining a long view on exit timing, you can ride the favorable capital wave when it arrives and avoid selling your company for less than it’s worth.

Employee Churn Risk Management

Employee churn risk is especially high for service businesses or specialties with a small labor pool. Currently, a war over AI programmers is creating havoc amongst tech companies. While these shifts in the industry most strongly impact smaller businesses, some small business advice can be applied to companies of any size. For example, here are some best practices of product marketing to manage labor market risk that everyone should follow:

1. Comprehensive Market Research. Use recruiters to keep in touch with demand for your key employees. Follow local job boards for competitive postings and monitor BLS statistics by occupation.
2. Define a clear talent strategy. Know who you want at your company and why they succeed there. Don’t just increase wages to attract employees – craft your values, culture, and compensation around what matters to your ideal employee.
3. Automation and delegation. Your business should be on a constant quest to automate, simplify, and delegate tasks to lower positions. This reduces your dependence on any one employee and promotes scale.

Partner with a Professional Risk Manager

Entrepreneurs are optimists, making them ill-suited for deliberative jobs like financial risk management. Partnering with a fractional CFO means you get conservative financial business advice grounded in solid small-business risk management.

To learn more, check out our CFO services.