Imagine you're at the helm of a thriving business. Your sales are positive, customers are satisfied, and on the surface, things look promising. Yet, despite the apparent success, financial stability still feels like an elusive goal; and you can’t help wondering why?
One possibility could be a mismatch between your business risk profile and your financial risk profile that leaves you vulnerable to shocks. Aligning your company’s financial and business risks is a balancing act that plays a vital role in improving the fundamental sustainability of your business. Understanding the interplay of these risks, and how to manage them properly, can transform how your company navigates the complexities of a volatile marketplace.
Before we proceed, it’s essential to clarify the concepts of financial and business risks in this context.
Financial risk will refer to the risks inherent in your capital structure such as the amount of debt, the price of debt, the repayment commitments and any other obligations linked to your company’s financial obligations. High financial risk typically means substantial borrowing or onerous debt repayment obligations. Other risks such as Market Risk or Operational Risk are often included within a discussion of Financial Risk, but for this article our focus will be on the risks inherent in the capital structure.
Business risk represents all the risks in the company’s business model and day-to-day operations. This includes external factors (e.g. competition), internal factors (like your cost structure) and tactical factors (e.g. supplier concentration). Business risk determines how volatile your company’s core operations are (or could become), independent of its financial structure.
This article aims to highlight the fact that these factors are inversely related when building a stable and sustainable business: an increase in one, necessitates a reduction in the other.
Does your company operate in a volatile industry (higher business risk)? Then aim for lower financial risk. Are you in a stable environment with predictable (but unimpressive) performance? Your growth strategy could accommodate higher leverage for better returns. Understanding and managing the relationship between these risks will help you improve the stability and sustainability of your business as you position for growth.
So how can you better understand and manage your business and financial risks?
Start by identifying your business risks
- The external environment – such as competition, customer behaviours, economic factors that impact your business or your industry, etc;
- The internal environment – including details like the fixed and variable cost split in your cost structure, your operational risks, etc;
- The tactical positioning of your business – things like client or supplier dependencies, reliance on imports or exports; the impact of technology on your industry.
Business risks are unavoidable but higher risk has the potential for shock events that can destabilise or even sink your business.
Take stock of your financial risks
- How much debt do you have relative to your earnings and your assets?
- What are your debt service obligations and how do they compare with your expected operation cashflow?
- What conditions, restrictions or covenants have you committed to that could trigger a default on debt that’s not yet due?
A simple rule of thumb – more is worse – more debt relative to assets means higher risk, more debt service obligations compared to earnings means higher risk, etc.
Look for imbalance in your business and financial risk profiles
If you judge your business risk to be high, how would you assess your financial risk? Knowing now that higher financial risk should be countered with lower business risk, identify the areas where you can make a meaningful impact in rebalancing these risks.
Implement risk management practices to rebalance your risk profiles
It’s generally easier to reduce your business risk than your financial risk since the cash required to pay down debt is probably not just lying around.
A good approach is to assess your business risks through a matrix of “Likelihood” and “Impact”. This prioritises your risks and directs your focus to those risks that pose the biggest threat (high likelihood and high impact). The actions you take will differ for every business, but action is necessary if you need to change your business risk profile.
Incorporate this exercise into your strategy and planning process
If you’re satisfied with your business risk profile, perhaps there’s room for financial risk in your growth plans? Perhaps your strategy needs revision to account for the business risk changes that are necessary to grow sustainably.
Perhaps this seems complicated, or maybe you don’t have the resources to give this the attention it needs. For many companies, the assistance of a Fractional CFO can be transformative. Bringing in a finance professional with the expertise and insights to drive meaningful change in your business without the financial burden of a full-time executive could unlock your growth.
A Fractional CFO can help you identify and take appropriate actions that help to rebalance your financial and business risks. They provide valuable insights and actions to help you with strategy, risk management, and improved financial operations. Through analysis, financial management best practice and practical experience, a Fractional CFO can help you achieve the strategy and goals you’ve set for your business.
When well-executed, aligning your financial and business risks will enhance your business’ sustainability. Once implemented, you can expect:
- Enhanced Financial Stability: Executing sound financial strategies that foster resilience through uncertainty and allowing you to focus on operational excellence and strategic execution.
- Reduced Financial Disruption: Implementing risk management strategies to identify and respond to potential issues proactively will reduce the threat of disruptions to your business.
- Improved Business Decisions: Armed with a better understanding of your risks, you can make better, well-informed decisions to grow your business with confidence.
Active risk management isn’t just an operational necessity, it’s the cornerstone for sustainable growth and success.
