Showcasing the 15 Ways to Mitigate Financial Risk.

By identifying and monitoring risks, a company is better positioned to mitigate their financial impact. The four approaches to mitigating financial risk are avoidance, reduction, transference and acceptance. Avoidance involves changing course to dodge the factors that cause the financial risk. Reduction takes the approach of managing through the risk but with measures to minimize its effects. Transference means off-loading or sharing some of the risk with other parties, such as business partners or insurance agencies. Finally, acceptance is the decision to move forward, accepting the potential consequences of the risk rather than taking action to mitigate or avoid it. Businesses may choose a particular approach based on the type of financial risk involved or they may opt to combine multiple approaches to address a risk. The 15 ways to mitigate financial risk listed here draw on all four approaches.
Carry insurance

Insurance is a way to transfer some financial risk to a third party. It comes in handy when paying for an unexpected loss, thereby preserving company capital. However, keep in mind that insurance policies carry premium costs, and while the proceeds of a claim can help finance recovery, they don’t eliminate the risk or the disruption. There are dozens of business insurance policies covering all kinds of financial risks, including product liability, crime, commercial property claims, workers compensation, business interruption and cybercrime.

Evaluate efficiency

By maximizing operational efficiency a business can unlock cash flow that can be redirected to cover the impact of financial risk. Additionally, the process of continually evaluating aspects of a business can help identify potential business risks.

Maintain emergency funds

Establishing cash reserves is a way to prepare for the impact of financial risks. Along with insurance, emergency funds can help lessen financial losses and keep a business running. Emergency funds can be internally generated through positive cash flow or they can be in the form of an accessible line of credit. Preplanning is necessary in both cases.

Invest in quality assurance (QA)

Instituting strong QA measures to make sure that products and services meet desired quality standards is a way to reduce product-related financial risks. Checklists, checkpoints, sampling and supervision throughout the production process can help ensure better outcomes.

Diversify business investments

Diversification is a way to spread risk across multiple areas. When businesses hold investments in other companies through stocks or ownership stakes, selecting a variety of industries helps minimize the risk that investments all rise and fall together. Further, diversifying investments between equity and debt can help minimize volatility and risk. Similarly, diversifying a business’s income streams, so as not to rely on a small number of products or customers, is another way to hedge financial loss and minimize risk.

Keep accounts receivable (AR) low

As AR balances age, collection becomes less likely. Uncollected AR results in lost revenue, reduced cash flow and lost profits, so it’s important to stay on top of the balances by using an AR aging report, which tracks the payment status of a company’s AR, or other similar tools. Additionally, AR vigilance can uncover customers that present credit risks so future sales terms can be adjusted to prevent future losses.

Read the fine print

Misunderstandings among commercial partners can cause all sorts of problems that can result in financial loss. Documenting agreements in writing helps reduce ambiguity and the likelihood of financial loss, especially when it comes to the finer details of an arrangement.

Reduce unneeded debt

Most businesses rely on loans from time to time to support gaps in cash flow and for long-term investments. However, it’s important to manage leverage risk by keeping loan balances as low as possible to avoid excess borrowing costs, such as interest charges and bank fees, as well as heavy cash flow drains from inflated loan payments. Additionally, lower outstanding loan balances can maximize a company’s available credit for emergencies and unforeseen challenges and opportunities.

Maintain quality records

Keeping quality records is fundamental to managing financial risk because it provides clean data for historical analysis and future visibility. It’s also a primary way to avoid compliance risk. Businesses have many reporting requirements from lenders, government agencies, industry regulators and shareholders to prove they are meeting regulations and abiding by the law. Non-compliance results in direct penalties and indirect reputational risk. Sloppy record-keeping increases the risk of bad decision-making and non-compliance, making maintaining quality records table stakes.

Create a cash management strategy

Running out of cash is one of the most common reasons that businesses fail. Creating a cash management strategy helps reduce financial risks through planning and prevention. Forecasting cash inflows and outflows, monitoring AR and accounts payable balances, managing debt payments, keeping an eye on currency exchange and interest rates and staying close to market demand all play a part in developing a cash management strategy and can help lower risk.

Invest in employees

Employees can have a big impact on the success or failure of a business. This is especially evident in services industries, but it’s also a factor that affects productivity in non-services industries. Because there is a direct correlation between the adequacy of employee training and business output, investing in employees reduces the risk of costly errors that can damage a company’s reputation.

Outsource when it makes sense

Outsourcing certain functions is one way to mitigate certain financial risks by saving time and money. Hiring third-party specialists to handle certain parts of a business can bring cost savings, thanks to the service provider’s economies of scale. Outsourcing can also save time because expertise is already in place. Financial risk is shared between the company and the service provider, and cost savings can be used to reduce risk in other areas of the business. Beware, though, that while outsourcing can reduce some financial risks, it may introduce others, so it’s important to evaluate where it makes sense.

Focus on metrics for decisions

Consider the adage, “You can’t manage what you don’t measure.” Using objective metrics helps lower financial risks by supporting impartial decision-making and helping leadership stay focused on tangible goals. Planning, measuring and using standardized, quality information can help keep a business on track and provide early warning if it’s not. Impulsive or under-informed decisions tend to increase the level of risk.

Leverage financial technology

The right financial technology can bolster the other tactics for minimizing financial risk. Robust technology, such as cloud-based accounting software and integrated enterprise resource planning (ERP) systems, is essential for identifying and analyzing trends that might become risks — or opportunities. Financial technology is useful for planning and developing metrics and reduces the potential for manual errors in record-keeping.

Establish separation of duties

A strong internal control environment helps reduce the risk of errors and fraud. The internal control environment is a network of processes designed to catch anomalies before they happen (prevent controls) and to detect them if they do happen (detect controls). Segregation of duties is a primary control that works by ensuring that no single person has full control of a single transaction, usually by separating functions like recording, approving, paying and reconciling. Segregation of duties can be a challenge for small organizations but can be assisted by the right technology.