Financial Risk Management for SMBs: Essentials for Success When You Don’t Have a CFO

Financial risk is an inescapable aspect of business ownership. But careful financial risk management can be the difference between struggle and success for small and midsize businesses (SMBs). 

Although large enterprises can split up the duties of financial risk management among the executive team, SMBs don’t always have that luxury. Even without a CFO, however, as CEO or founder, you can plan for growth and take proactive steps to mitigate risk and protect your company’s financial health.

What Are the Main Financial Risks for SMBs?

A financial risk is anything that increases the possibility of adverse financial repercussions to your business, such as damage, liability or loss. Because there are many different types of risk, breaking them down into general categories can be helpful. Three major risk categories are credit risk, market risk and operational risk.

Credit Risk

Credit risk is the possibility that a business will be unable to pay its debts, whether to a financial institution, supplier or other issuer of credit. Unpaid debts incur fees, which further interfere with cash flow and, in turn, can lead to a chain of unmet credit obligations. Even when resolved, a high level of credit risk can negatively impact your ability to negotiate for loans or obtain supplies on credit. 

Managing Credit Risk

Controlling the financial implications of credit risk requires both proactive planning and the ability to adjust as needed. 

Here are some best practices your company can use to manage credit risk:

• Pay your debts and bills on time. The more consistently you pay your bills on time, the more likely creditors will be to support you during a cash flow disruption.
• Monitor your accounts receivable carefully, following up immediately when you are owed money. Consider setting late fees or discount terms for early payment to maintain your cash flow.
• Avoid over-reliance on key clients to ensure your income is stable and continuous. Expand your customer base as much as possible.
• Borrow only as much as you need, and never for speculative purposes.

Market Risk

Market risk is the potential for unexpected change in the broader market environment. Those changes might come from evolving regulatory standards, fluctuating consumer demand, new competition or other random factors. For instance, the COVID-19 pandemic caused seismic changes to the marketplace, requiring new distribution channels, throwing the global supply chain into complete disarray, and forcing workers to find new methods of interaction, all at the same time. 

Managing Market Risk

Not all market changes are as abrupt or overwhelming as a global pandemic, but most are largely beyond your control. Managing the financial impact of market risk, therefore, focuses on preparation and resilience. 

Here are some best practices your company can use to manage market risk: 

• Diversify your offerings to broaden your revenue stream. The more sources of revenue available to you, the easier it will be for your business to weather abrupt market changes.
• Forecast for multiple business conditions, not just the most or least optimal.  Test “what if?” scenarios with financial models to predict outcomes and resource allocation under unusual circumstances. 
• Have insurance. Your SMB is unique, as are your insurance needs, so find a plan that will cover your most pressing requirements in an emergency.
• Make contingency plans. Explore your potential to pivot or reposition in the face of unplanned changes to the broader market landscape. One way to do this is by using scenario analysis to adjust your cash flow projections. 

Operational Risk

Operational risk is the potential for loss caused by internal factors affecting day-to-day business operations. Human error and incomplete processes contribute to operational risk, as do health and safety incidents, system failures, and theft or fraud.

Managing Operational Risk

Unlike market risk, many factors causing operational risk are preventable, or at least under your control. Managing the financial consequences of operational risk involves careful process and systems planning, though the exact details will be unique to your sector and personalized for your offering.

Here are some best practices your company can use to manage operational risk: 

• Implement rigorous internal financial controls. For example, establish a system for approving and reviewing accounts payable and receivable transactions to help detect and prevent fraudulent activity. 
• Create standard operating procedures (SOPs). Documenting your financial processes and procedures (e.g., invoicing and billing, travel expensing, payroll processing, etc.) helps ensure accuracy, consistency and continuity as employees leave or join the team. 
• Standardize workflows for your teams and products. This might include automating specific processes to avoid human error, including automating your month-end close. Procedural consistency provides a chain of responsibility to guide and safeguard every employee.
• Establish an internal audit schedule to examine and investigate key financial activities regularly.
• Protect your business against data breaches, phishing attacks and ransomware attacks—especially amid growing evidence that cybercriminals are targeting SMBs. You can start by implementing IT security controls, like using strong passwords, limiting access to cloud financial systems and regularly backing up data.

Compliance: An Essential Part of Financial Risk Management

Maintaining tax and regulatory compliance is another vector of financial risk management for small businesses, particularly for companies without in-house expertise. Oversights or missed deadlines can be expensive: fines and penalties are not only costly in the present, but they can also lead to missed opportunities in the future. 

Here are steps you can take to shore up your compliance: 

• Be aware that the regulatory environment evolves constantly. The SEC issues regular Risk Alerts to inform companies of their requirements. It is vital to stay informed on these changes and updates. 
• Keep your financial records complete and up to date, both for the purposes of timely tax filings and to streamline external audits. 
• Educate your staff on the financial consequences of their actions and decisions. For example, talk to your staff about the importance of reading and adhering to vendor contract terms. Help them understand that failing to do so could lead to penalties or legal disputes. 

Additional Compliance Standards To Be Aware Of

To determine which regulations or standards apply to your SMB, consider your industry, who you do business with, and the types of data your business handles. The following chart outlines some common regulations and standards you should be aware of.

Successfully Manage Your Financial Risk With Paro’s Fractional CFOs

As CEO, you can implement financial risk management strategies whether or not your SMB has a full-time CFO. Alleviating risk is crucial to sustainable growth and must be a key priority.

Mitigate credit risk by optimizing cash flow and proactively monitoring your debts and accounts receivables. Temper market risk by diversifying your offerings and broadening your customer base. Manage operational risk by establishing robust internal controls and audit schedules. 

If your business has a lean finance function, explore the expert support available through Paro’s fractional CFO services. Maximize your cash flow with guidance from Paro’s experienced network and enact financial procedures and processes to ensure compliance. A fractional CFO can further refine your growth strategy and position your company for future success.