Financial risk management requires rigor and anticipation. As CFOs know, every grain of sand in the machinery has a cost, with varying degrees of impact on operations. Risk management is therefore a strategic challenge, particularly in a tense economic and geopolitical climate.
How can you limit the impact of internal or external factors and preserve your company’s financial equilibrium? Sound risk management involves identifying the main threats and defining an effective prevention policy.
What financial risks do companies face?
There are many risks, and not all of them will have the same impact on your business, depending on the sector or size of the entity concerned. For example, an SME with international operations will have to focus on exchange rate variations.
Macroeconomic risks
These risks include economic and political risks external to the company. This may include:
- Inflation: expenses rise as suppliers adjust their prices, affecting your sales margins.
- Rising interest rates: making it harder to obtain financing and slowing down the development of operations.
- Periods of recession and economic crises, like the one in 2008, temporarily weaken and paralyze different business sectors.
- Health crises: in 2020, Covid profoundly disrupted society and consumer habits.
- Conflicts: Ukraine and the war between Israel and Hamas illustrate the impact of global instability, which is difficult to manage.
- Government policies and regulations can change the economic landscape and impose new constraints, as seen with Brexit, international sanctions, or the GDPR.
- Technological advances: the development of AI in particular can have both positive and negative effects that need to be taken into account.
While CFOs don’t have a crystal ball to predict this kind of event, they must nevertheless factor macroeconomic risks into their analysis.
Operational risks
Operational risks lead to financial losses, and involve failures in procedures, personnel, internal systems, or external risks.
They can affect the production line directly, in the case of technical breakdowns, execution errors, or delivery failures. They can also be linked to employees, suppliers, customers, or the company’s administration. They include:
- internal fraud (embezzlement, falsification of documents, theft, expense abuses);
- industrial accidents;
- staff strikes;
- disputes relating to invoicing or missed payment deadlines;
- stockouts; and
- non-compliance with legal, accounting, or tax rules.
Other risks that threaten the smooth running of operations include external fraud (cyber-attacks, identity theft, industrial espionage, etc.) and reputational risk, where the company’s image is tarnished in the eyes of the public or its partners.
Pure financial risks
Cash shortages are one of the main causes of business failure. To guard against this, CFOs need to monitor various indicators and prepare provisional cash flow budgets that include liquidity risk, as well as other parameters, depending on the nature of their business:
- Foreign exchange risk: currencies are highly volatile on the foreign exchange market, affecting the price of raw materials or contracts in local currency.
- Counterparty risk: a customer may be unable to pay its debts.
- Investment risk: risky investments will expose the company to potential capital losses.
3 steps to effective financial risk management
The range of risks with a potential financial impact is vast. Finance managers are responsible for identifying the major risks for their company and for defining a strategy to manage them.
1. Identify and assess your financial risks
For effective financial risk management, you need to structure your approach and map out the various threats or missed opportunities, using risk exposure diagnostics. This will enable you to identify the risks facing your company, and to prioritize them according to their probability of occurrence and potential damage.
The other essential point is to evaluate existing control and prevention measures, as well as the responsibilities of each party in the event of proven risks. This will give you a clearer picture of the actions to be taken.
2. Implement a strategic risk management plan
It is impossible to guard against all risks, so you need to prioritize certain risks and define a prevention plan with your objectives in mind:
- preserving the company’s value, assets, and reputation;
- safe-guarding decision-making.
Some risks are transferable and can be covered by a hedging contract or insurance. This is the case for property damage, natural disasters, or bad weather that brings production to a halt, as well as for foreign currency transactions or loans.
For other types of risk, you need to define the appropriate treatment:
- reduction, by diversifying your activities, for example;
- elimination, by selling a subsidiary or discontinuing a product;
- accepting the risk and not hedging it.
To decide which actions to prioritize, you will need to consider the trade-off between the costs and benefits of the measures to be implemented.
3. Monitor your risk exposure
The success of your system depends on your ability to monitor it and improve it where necessary. You need to list the indicators to be monitored and make your teams aware of the challenges of risk management by drawing up clear procedures.
It is in your interest to regularly review your prevention plan to identify new risks. Three areas are evolving rapidly: regulation, technology, and fraud. Even if previous digital innovations have not affected your industry, the next one may hit your business hard.
Financial risk management: Key tools
Enterprise Risk Management (ERM) software can help you to structure your approach. These tools detect and analyze risks thanks to their powerful data management capabilities. They also generate reports essential for decision-making and generally offer a centralized, real-time view of the various indicators.
They serve both to protect the company from potential damage and to identify performance-improvement opportunities. When choosing the tool best suited to your objectives, opt for a simple, intuitive, and collaborative solution that integrates with your existing system.
Generally speaking, when selecting software, you need to take various criteria into account, such as the tool’s regulatory compliance. To find out more, read our article on 5 good reasons for choosing an expense report management app.
