Small and midsize enterprises (SMEs) face substantial internal and external financial risks that can cause them to fail. Data from the U.S. Bureau of Labor Statistics (BLS) indicates that 20% of small businesses fail within their first year, 50% fail within the first five years, and 70% fail within 10 years. SMEs typically do not have substantial cash reserves to carry them through rough times, making it important to manage financial risks in multiple areas of business.
Identifying financial risks and mitigating them can help your business continue operating even in the face of challenges and reduce the chances of business failure. Here are some strategies SMEs can use to address financial risks.
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SMEs face multiple risks in various categories. It’s important for you to know your business’s risk profile and the risks that your business faces.
1. Internal Risks
Small and midsize businesses should evaluate the internal risks they face. Some of the common internal risks SMEs face include the following:
- Employee theft of goods
- Lawsuits filed by disgruntled employees
- Loss of customers due to poor customer service
- Losses caused by high turnover rates
Small businesses suffered the highest losses from internal thefts and fraud at a median loss of $150,000, according to the 2022 Report to the Nations by the Association of Certified Fraud Examiners,. While a large corporation might be able to deal with a loss of this size, most SMEs cannot, making it important for you to protect your business against internal financial risk.
2. Operational Risks
The operational risks faced by your business include those risks that arise during your operations and could result in losses. Operational risks are anything that could affect your business’s operations, including cybersecurity breaches and natural disasters.
3. Reputational Risks
Damage to your business’s reputation could threaten the survival of your company. These risks might occur because of actions of negligent employees, your company’s actions, or from your suppliers or partners. Reputational damage can affect your relationships with your customers and clients and adversely impact your business’s profitability.
4. Strategic Risks
Risks can arise when you’re trying to achieve strategic goals that prevent you from succeeding. These types of risks can occur because of changes in demand, human resource problems, increased competition, industry changes, market changes, and others.
1. Create a Financial Risk Management Plan
It’s critical for you to create a financial risk management plan to identify the financial risks your company faces and the steps for effectively managing them. When you identify your risks, it helps you prepare and have cost-effective strategies in place to deal with them.
For example, many small businesses are victims of employee theft and fraud. Others face risks when their employees work at client sites and damage property or engage in misconduct. A good way to manage these types of risks is through fidelity bonds. These are products that protect businesses from the wrongful actions of employees. The common types of fidelity bonds include the following:
- Business services bonds – Protect businesses when their employees cause damage at a client’s site
- Employee dishonesty bonds – Protect businesses against embezzlement, internal theft, forgery, fraud, and employee dishonesty
- ERISA bonds – Protect against fiduciary malpractice in the management of employee benefits plans
- Janitorial bonds – Bonds for cleaning companies to protect against employee thefts at client properties
When you create your financial risk management plan, evaluate the likelihood that the identified risks might occur and the impact they would have on your business. Have systems for managing the potential impacts of those risks if they do occur.
2. Prepare for the Unknown
You need to be prepared for unexpected events. A good way to do this is to make sure you have good strategies for managing your business’s cash flow. Many businesses fail because of poor cash flow. Having a good cash flow can allow you to cover your obligations, pay without having to rely on credit, be able to move forward with new opportunities, and provide you with the flexibility your business needs to manage downturns.
Prepare cash flow statements and regularly analyze them. Use strategies to address delinquent payees and implement cash flow forecasting to gain more insight into your future financial position.
3. Don’t Commingle Your Business and Personal Funds
When you commingle your business and personal funds, it can expose you to liability if lawsuits are filed against your company. This could endanger your credit, finances, and assets. Having a separate business account also helps your business build credit, and it makes tax preparation for your business much easier.
4. Get the Right Types of Insurance
Make sure you have all of the types of insurance coverage you need, including commercial general liability insurance, workers’ compensation insurance, commercial property insurance, and others. Having sufficient insurance coverage in place can protect your business against substantial losses and penalties.
5. Know and Comply with Regulations and Laws
You need to understand the regulations that govern your industry and ensure that you remain compliant with them. If you violate your legal requirements, your business could face significant fines and penalties. In some cases, regulatory violations could force your business’s closure.
6. Build Your Cash Reserves
Most people know that they should have six months’ worth of their daily living expenses saved to protect them in financial emergencies. The same is true for SMEs. You should work to build cash reserves and have a line of accessible credit available to carry your business through rough times. Strive to save six months to one year’s worth of your regular business expenses to protect your company from harm.
Financial risk management involves many considerations. However, identifying the risks your business faces can help you mitigate them. When you prioritize your company’s financial risks, purchase fidelity bonds and the right types of insurance, build your cash reserves, and ensure you comply with all relevant laws and regulations, you might increase your business’s chances of success.
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