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What strategies can SMEs implement to effectively manage financial risks?

Amidst the dynamic landscape of the business world, small and medium-sized enterprises (SMEs) grapple with a myriad of financial challenges.

At the forefront of these challenges lies the critical task of managing financial risks, a factor that holds the potential to significantly shape the sustainability and growth trajectories of SMEs. In an age characterized by economic uncertainties, globalization, and rapid technological advancements, the proactive handling and mitigation of financial risks emerge as imperative for the success of SMEs.

This week, in the latest edition of Let’s Talk, our experts engage in a discussion exploring the strategies that SMEs can employ to effectively navigate and mitigate financial risks.

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Ryan Williams, Director of the Australian Centre for Business Growth

Ryan Williams, Director of the Australian Centre for Business Growth

“Effective financial management is vital for businesses, especially in preparation for more uncertain times. When it comes to managing financial risks, the first vital step is to ensure you’re tracking financial performance on an appropriate timescale. For example, if you’re a retail business, you probably want to watch revenue figures and cash flow daily, keeping an eye on upcoming debts.

“The next crucial step is to secure sufficient access to cash or cash provisions to buy you a period of runway, serving as a financial safety net. This will vary from business to business, but it might range from a three-month cash reserve to a revolving credit facility covering a month’s working capital. This is so you’ve got an ability to weather external shocks, whether that’s a border shutdown, supply chain disruption or a meltdown in digital communications.

“And lastly, maintaining a strong relationship with the top 80% of your key suppliers will make it easier to negotiate during financially challenging periods.

“To sum up: a combination of vigilant, regular financial tracking, sufficient cash access, preparation for external shocks and solid supplier relationships forms the backbone of sound financial management to effectively manage risks.”

Kathy Sozou, Partner at McGrathNicol Restructuring

Kathy Sozou, Partner at McGrathNicol Restructuring

“Hope is not a strategy. The first step is to ensure that SMEs have appropriate systems and support in place to properly understand their financial position and performance. Financial accounts are often perceived as a requirement to satisfy stakeholders or authorities. But they are also an important management tool, vital in the assessment of financial risk and therefore, key to the development of appropriate mitigation strategies.

“Once the financial position is understood and risks have been assessed, it is important to proactively engage with key stakeholders such as lenders, suppliers and customers if there is an expectation that their co-operation will be required to help in a turnaround or restructure.

“Directors and business owners need to be able to articulate that they both understand the financial risks in their business and have a viable plan to address them. Often, if these discussions are left too late, stakeholders will lose faith in business leaders’ ability to navigate those risks appropriately.

“Generally, SME leaders can take the following steps to effectively manage financial risks:

Collate accurate, timely financial data to assess risks early

Develop risk mitigation strategies

Proactively engage with key stakeholders to create an environment of trust in your ability to manage those risks.”

Andrew Ward, Chief Risk Officer at Banjo Loans

Andrew Ward, Chief Risk Officer at Banjo Loans

“Financial risk management is a critical part of running an SME and business owners need to have a plan to manage and mitigate these risks.

“A plan is a key part of running your business to ensure that it’s sustainable, and you can adapt to changes in the economic environment and are appropriately rewarded for the risk that you are taking.

“Financial risks could include significant borrowings in your business; the financial exposure to foreign currency movements if you are an importer or exporter; or the credit risk of your customers not paying your invoices.

“It’s important to understand and identify the material financial risks that exist in your business and have cost effective processes to mitigate them.

“These risks and mitigants should be documented in a plan that is updated regularly as your business grows, and as the economic environment evolves.

“A good financial risk management plan will enable you to optimise your business opportunities and reduce the downside impact if a risk materialises.

“You can seek support in establishing a financial risk management plan through advisors such as your broker, banker, accountant, lawyer and other professionals.”

Caitlin Zotti, Co-CEO at Pin Payments

Caitlin Zotti, Co-CEO at Pin Payments

‘The biggest financial risk most small and new businesses face is cash flow management. In the early stages, it’s a good idea to ensure you diversify your revenue streams, if possible, as a buffer in case you encounter any unforeseen expenses.  Likewise, budgeting and cost control are extremely important for SMBs who are often operating on smaller profit margins.

“One of the greatest concerns for small businesses is actually getting paid on time. Almost half of SMBs in Australia are dealing with the issue of late payments, according to the 2022 Xero Small Business Insights Report, which showed 48% of invoices issued by Aussie small businesses are paid late, and 10% are paid more than a month after they’re due. This has a huge impact on a businesses ability to operate and ability to scale, as it can prevent a business leader from taking new opportunities or risks due to financial concerns. One way to assist this is to ensure you have the right technology and tools in place to automate your processes and follow up accordingly. Make sure you have a payments provider and accounting service that works for your business, to ensure you aren’t missing out on payments due to human or operational errors.”

Anthony Rous, CFO ANZ at Employsure

Anthony Rous, CFO ANZ at Employsure

“Running a small business can be incredibly rewarding, but it also brings with it a high financial risk and complex legal and statutory requirements. The majority of small businesses are started out of passion, rather than stemming from financial nous and an understanding of the legal landscape. As we know, financial management is only one of the many hats that small business owners wear!

“I’ve found that over many years of working in finance, there are some broad areas that business owners can consider when they’re assessing their own financial risks.

First and foremost, conduct an external risk assessment, delving into potential external factors or market trends that could impact your business operations. Have in in-depth understanding of possible external scenarios will help you prepare for most extreme events that may come your way. Dare I mention the recent ‘unprecedented times’ we’ve all experienced.

Understand your competitors and barriers to entry for new competitors. How quickly can an online competitor be set up somewhere across the globe that could significantly impact your business idea and plan?

A critical activity for any business is managing cashflow and forecasting cash flow. As they say, and it was seen in the GFC as well as during Covid lockdowns “CASH IS KING”. This will help ensure you have enough cash reserves to see you through challenging periods.

Understanding your business trends and habitual peaks and troughs throughout the year will have a flow on effect across many aspects of your business, such as planning a lean yet well-resourced workforce.

Regulatory and Statutory requirements – research what is required for a new company, when do documents need to be lodged, what payroll and HR impacts should you have employees as well as maintaining accounting records for tax purposes.”

Kevin Higgins, Executive Director of Vantage Performance

Kevin Higgins, Executive Director of Vantage Performance

“In today’s dynamic business landscape, it’s more important than ever to carefully manage financial risk. In our work with start-up, turnaround and high growth SMEs, we have found the following strategies very effective when it comes to managing financial risk:

Build a strong relationship with your funder. The more your funder understands your business, the faster they can act when you need some top up working capital or an extension of your facility when you are experiencing working capital challenges.

Assess your customer or supplier risk. How reliable are your customer and supplier relationships? If your business relies heavily on a select few customers or suppliers, we recommend diversifying and engaging with multiple counterparts to decrease dependence and mitigate your risks.

Integrate a contingency plan. Having a ‘playbook’ in place to deal with unexpected events is crucial for a business to respond effectively and efficiently. This may involve identifying a plan for each key stakeholder and a plan for a liquidity event (can’t pay for payroll or rent next week, for example).

“Businesses that adopt a proactive approach to financial risk management will emerge stronger and better equipped to take advantage of future growth opportunities.”

Trena Blair, CEO of FD Global Connections

Trena Blair, CEO of FD Global Connections

“SMEs can implement several key strategies to effectively manage financial risks in 2024.

Diversification: Spread financial investments across different assets and industries to minimise the impact of a downturn.

Cash Flow Forecasting: Regularly analyse and forecast cash flows to anticipate potential gaps allowing for better decision-making and avoiding liquidity issues.

Insurance Coverage: Invest in comprehensive insurance coverage to mitigate risks associated with property damage, liability, and other unforeseen events.

Strategic Partnerships: Collaborate with reliable partners and suppliers who can support you during harsh economic conditions and create a more resilient business ecosystem.

Adopt IT: Leverage technology to streamline processes, monitor transactions, and detect anomalies promptly.

Regular Financial Health Checks: Conduct periodic financial health reviews, scrutinising key metrics. Identify potential areas of improvement and implement necessary adjustments.

Regulatory Compliance: Stay abreast of regulatory changes that may impact your industry. Compliance ensures that your business is prepared for legal and financial challenges.

Currency fluctuations: For businesses with offshore operations, embed systems to monitor currency fluctuations. Use forward contracts to hedge exchange rates and lock in rates for up to 24 months.

“By incorporating these strategies, SMEs can proactively navigate uncertainties and build a robust foundation for sustainable growth throughout 2024.”

Andrii Bezruchko, CEO and Founder at Newxel

Andrii Bezruchko, CEO and Founder at Newxel

“Financial risk management” is about understanding the inputs and outputs of a business. Here are some questions that every business owner needs to ask themselves: “What happens if the revenue drops to zero? What happens if I can’t pay my suppliers? What happens if my suppliers don’t pay me?

“Here are some tips SMEs can use to address financial risks:

Plan for the worst and work toward the best
A way to do that is stress-test modeling. When creating forecasts, run several scenarios to see how your business would be affected, and have contingency plans in place so you are as prepared as possible for all outcomes. If you’re a first-time business owner – rely on professionals, and learn your lessons from them, not from your failures.

Cash is a king
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. Maintain a robust cash flow management system. This involves monitoring accounts receivable and payable, negotiating favorable payment terms with suppliers, and ensuring that there’s always enough liquidity to cover operational expenses for at least 6 months.

Diversification of revenue streams
SMEs should avoid relying heavily on a single client or revenue stream. SMEs to be adept at steering through the volatilities of markets and the uncertainties of geopolitics. By diversifying revenue streams, businesses not only fortify themselves against the jolts of financial downturns but also cultivate resilience amid the unpredictable shifts in global markets and geopolitical landscapes. This strategic maneuver not only safeguards against potential pitfalls but also positions SMEs to seize opportunities with agility and foresight.”

Mollie Eckersley, Operations Manager, ANZ at BrightHR

Mollie Eckersley, Operations Manager, ANZ at BrightHR

“Managing a business is synonymous with managing risks, especially when you’re an SME owner.

“SMEs face a variety of challenges in the current business landscape that even established corporations would struggle to navigate. That’s why the best financial risk management strategies for SMEs are the ones that establish agility and proactivity.

“Some of the biggest financial risks for SMEs in Australia is the risks of breaching employment relations and health & safety laws, which are notoriously complex and carry hefty fines and penalties. That’s why businesses need professional advice and prompt compliance support that helps them avoid falling behind on their legal obligations.

“Another crucial quality businesses need to maintain to stay agile is visibility. More visibility into an SME’s financial health means greater control, which unlocks more proactive management of those risks. Software tools that help track expenses, for example, make that cost overview straightforward and accessible. It allows SMEs to ditch the manual paper trail and digitalise the process of expense claims from end to end. So, come tax time all the information is easily available to help boost tax savings.”

Tracy Ford, Founder & HR Consultant at Concept HR Services

Tracy Ford, Founder & HR Consultant at Concept HR Services

“Interestingly, if you do an internet search on “financial risk for businesses” employment factors don’t feature. This could be attributed to the inherent challenge of quantifying and measuring in this area.

“In my work with SMEs, I help reduce financial risk through effective HR processes and practices. Effectively managing employee-related financial risks for SMEs involves paying attention to several areas, but for today’s purpose I’ll focus on three, namely employee turnover, legal compliance, and poor performance.

“High employee turnover leads to increased recruitment and training costs, reduces operational output and customer service, and affects team morale, making employee retention strategies vital. This includes offering competitive benefits, development opportunities, and fostering a positive work environment.

“Legal compliance risks stem from non-adherence to employment laws, potentially resulting in fines and legal expenses. Regular reviews of policies and seeking expert advice are essential for maintaining compliance with regulations governing employment.

“Addressing poor performance is crucial to maintaining overall productivity and financial health. Implementing robust performance management systems, providing leadership development, and fostering a high-performance culture are key strategies.

“Proactive measures in these areas help SMEs create a stable and productive workforce, reducing financial risks associated with employee-related challenges.”

Paul Edginton, CEO at Structured Innovation Pty Ltd

Paul Edginton, CEO at Structured Innovation Pty Ltd

“A focus on value creation not only drives profitability, but provides SMEs with a robust framework to manage financial metrics and attract the best talent. SME leaders need to have a clear plan for how they manage financial risks and opportunities. A strong plan encompasses both business Mechanics and Dynamics.

“Business Mechanics consist of three key components: cashflow, profit and loss and your balance sheet. While many SMEs micromanage cash flow and monitor performance against budgets (P&L), many lack a robust strategy for balance sheet growth, missing opportunities to grow the wealth, value and capacity of the business each year. A well-crafted balance sheet strategy provides a longer-term view, exploring options such as supply chain divestment, property leverage, or mergers and acquisitions, which are often more valuable ways to grow a business.

“Business Dynamics are the vital human aspect of financial management. Dynamics shape discussions about money and aspirations for the business’s financial stability and growth. Dynamics influence financial strategy and guide conversations with financiers, shareholders and banks.

“SME leaders must think about how Mechanics and Dynamics affect: the way they talk about profits, assess their financial literacy, set financial targets and plan for growth, reinvestment, dividends and debt retirement. The key to managing financial risk is to identify your metrics and targets through the lens of Mechanics and Dynamics in financial performance. Set targets, review targets, reset targets and most importantly deliver value!”

Olivia Jenkins, Business & Marketing Consultant, Olivia Jenkins Consulting

Olivia Jenkins, Business & Marketing Consultant, Olivia Jenkins Consulting

“In the realm of small and medium-sized enterprises (SMEs) in Australia, effective cash flow management is the cornerstone for mitigating financial risks.

“As a Business & Marketing Consultant specialising in this sector, I believe that maintaining a healthy cash flow is more than just tracking revenue and expenses – it’s the lifeline of a business, determining its success or failure.

“A key strategy is the implementation of budgeting and forecasting. This involves regularly updating financial forecasts to reflect current market conditions and adjusting budgets accordingly. By doing so, it empowers SMEs to foresee and prepare for potential financial challenges, rather than reacting when it’s too late.

“Invoice management is another critical aspect. Efficient invoicing and follow-ups ensure faster payments, which helps reduce the gap between expenditure and income. Additionally, offering various payment options can accelerate this process, improving overall cash flow.

“SMEs should also establish an emergency fund to act as a buffer against unforeseen expenses or market downturns, ensuring business continuity.

“In essence, by mastering cash flow management through strategic budgeting, efficient invoicing, and maintaining a financial safety net – SMEs can significantly reduce their financial risks and enjoy sustainable growth and stability.”

Billie Sharp, Small Business Expert, Coach & Entrepreneur, Billie Sharp

Billie Sharp, Small Business Expert, Coach & Entrepreneur, Billie Sharp

“Diversify: Don’t put all your eggs in one basket. Spread your investments and revenue streams. I recommend a minimum of 3 key income streams per business.

Cash is king: Keep an eye on your cash flow. It’s the lifeline of your business. Make sure there’s always enough money in the bank to keep things rolling smoothly. Have clear payment terms to protect yourself and consider payment in advance for products and services.

Rainy day fund: Just like having an umbrella on a cloudy day, stash away some cash for unexpected surprises. You never know when you’ll need it, and trust me, it’s better to have it and not need it than the other way around.

Know your numbers: Stay on top of your financial statements. Be buddies with your balance sheet and pals with your profit & loss. The more you know, the better you can navigate the financial waters. This also helps you make informed decisions and removes the guesswork.

Insurance: It’s costly, and annoying, but essential. Don’t skimp. Make sure you are fully covered.

Build relationships: With your suppliers and customers. Strong relationships can help you negotiate better terms and maybe even get a little wiggle room during tough times. It also helps with client retention and without that, growth slows by around 79%.”

Dhanush Ganglani, Managing Director at Eden Exchange

Dhanush Ganglani, Managing Director at Eden Exchange

“Small and medium-sized enterprises (SMEs) face diverse financial risks when buying or selling a business. Implementing prudent strategies helps to mitigate these risks.

“This could look like:

Conducting thorough due diligence: Scrutinise financial statements, assess market conditions and evaluate potential risks and liabilities.

Diversifying their revenue streams and customer base: Overreliance on a single client or product can make the business vulnerable to market fluctuations. Building a cash reserve serves as a safety net during economic downturns or unexpected expenses, reducing the impact of financial shocks.

Adopting conservative financial practices: It’s simple, but needs to be said. Borrow prudently and manage cash flow efficiently.

Having a contingency plan in place and regularly reviewing and updating financial strategies: This allows for timely adjustments in response to changing market conditions.

“And, if nothing else, consider enlisting the advice of experts who can offer support from lead and deal origination to preparation and transaction all while mitigating any financial risk along the way.”

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