“The higher the risk, the higher the return” is perhaps the most common principle of investing familiar to entrepreneurs.
However, the focus is often more on return than risk, focusing on the positive rather than the negative. Many consider risk management costly and complicated. Its contributions to revenue generation are not as clear and obvious as those of profit (or yield) management. Little attention is paid to risks and businesses, especially micro, small and medium-sized enterprises (MSMEs), become vulnerable to changing economic and market conditions.
Every business faces risk. No matter how prepared, educated and experienced business owners are, internal and external risks can harm their company’s finances or even reputation. Risk management doesn’t have to be expensive and complicated. It only requires, at a minimum, a good appreciation that the future might not go as planned, and so business owners need to be prepared. Although there is no one-size-fits-all approach, there are areas that MSMEs can work on.
Liquidity risk management should be a top priority, especially for early stage MSMEs. Business owners often invest their hard-earned savings – for some the proceeds of huge personal loans – to start their businesses. Therefore, the pressure to succeed is exorbitant.
A survey conducted by the Asia-Pacific MSME Trade Coalition in April 2020 – at the height of the Covid-19 pandemic – revealed that the main challenge for MSMEs was the lack of operational cash flow. Just a month after the government imposed a strict lockdown, 50% said they had less than a month or just a month of cash reserves. Cash reserve problems, however, do not arise overnight. These accumulate over time, in different forms, as business owners are busy dealing with what seem like obvious problems at the time.
To mitigate liquidity risk, business owners need to keep an eye on their current and future finances. This can be operationalized by knowing the cash flow timing. This includes sales, purchases, salaries, operating expenses and unforeseen expenses. On a regular basis, business owners need to know their financial situation by calculating the amount of cash available and how long this will cover expected cash outflows. This essential financial information will help warn business owners of liquidity risks.
The explosion of consumer presence on social media platforms has made reputational risk a vital concern. Corporate reputation is not reflected on a company’s books; it is an important off-balance sheet asset that grows the business. Social media is a double-edged sword that makes reputation management for businesses more difficult and, at the same time, easier. It’s more difficult because customers can easily access Internet forums with large audiences and trigger negative reviews without being content. It’s easier, meanwhile, because positive, happy reviews can serve as advertisements that encourage other consumers to patronize the business.
A recent BrightLocal survey found that more consumers are reading reviews online than ever before. In 2021, 77% “always” or “regularly” read reviews when researching local businesses (up from 60% in 2020). Additionally, 67% said they would consider leaving a review for a positive experience, while 40% said they would consider leaving a review for a negative experience. Given these statistics, it’s a must for business owners to initiate and own the exchange of thoughts. Investing effort and time into listening to customer reviews and professionally acknowledging and responding to reviews can encourage customers to become more engaged with the business.
Power and internet outages, inclement weather, employee absences, and supply chain issues, among others, can disrupt business operations. These can lead to missed opportunities, loss of customer relationships and, worse, the inability of the business to operate. MSMEs can prepare by having a business continuity plan (BCP). As a risk management tool, BCPs don’t need to be complicated. A good BCP should, at a minimum, articulate the risk or disruption, the actions to be taken by employees within a specified time frame, and a discussion of continuous improvement. Having a good BCP gets business operations back on track as soon as possible.
All of these approaches to risk management will not be meaningful or effective unless business owners communicate them properly to employees and other stakeholders. Having a common understanding will support consistent, risk-based decisions. It will be much easier to work on returns when everyone knows the risks are being actively managed.
Risk management may not have a direct impact on short-term returns. This will, however, allow MSMEs to earn more with certainty in these uncertain times.
Seb Serrano is a Senior Management Consultant for Advisory Services at P&A Grant Thornton. P&A Grant Thornton is one of the Philippines’ leading audit, tax, advisory and outsourcing firms, with 22 partners and more than 1,000 associates. We would love to hear from you! Tweet us at @GrantThorntonPH, like us on Facebook at P&A Grant Thornton and email your feedback to [email protected] For more information, visit our website at www.grantthornton.com.ph.