— August 20, 2019
It is always a good idea to review your risk exposure from time to time and develop a plan to deal with things before you are forced to deal with them during a crisis. Previously, we looked at operational business risk. In this post, I’d like to discuss both Financial and Governmental Risks that your business may face so you can consider ways to mitigate the effects if things go wrong.
Small business risk comes in many different forms. Some you’ll be able to prepare for and some that you can’t. Both a PESTEL analysis and Porter’s Five Forces allow a business to consider the macro-environmental and micro-environmental forces that can alter the risk profile of a business.
Financial Business Risk Defined
Financial business risk is where external factors can cause a business to lose money. Financial business risk has the potential to produce damaging results for the business. An example of financial business risk is when a customer declares bankruptcy, leaving you unable to pay your bills since you haven’t been paid.
Financial business risk can be broken down into four types of risks.
Credit risk is where individual consumers or businesses to whom you have extended credit fail to pay you. Credit risk is sometimes called accounts receivable risk.
The absence of a payment or delays in payments will strain a company’s financial resources. This results in cash flow issues that have been known to destroy many small businesses.
It is always recommended to run a credit report before you sign any contracts as a way to assess the creditworthiness of the other party. As tempting as it may be to engage with the customer, partner or supplier in a lucrative deal, one that has poor credit is a recipe for financial risks.
Reference USA is a tool offered by many pubic libraries which can provide a basic credit rating of any potential customer, partners, and suppliers for free.
Currency risk is where volatile foreign exchange rates can impact the value of a business transaction and or its assets. Currency risk is sometimes called exchange rate risk.
Many businesses today use off-shore resources or buy or sell goods to and from other countries. When the exchange rate between your country of origin and where you purchase or sell goods and services changes, it introduces currency or exchange rate risk.
Interest Rate Risk
Interest rate risk is where a change in interest rates affects a business’s profitability. Interest rate risk can be self-induced or externally-induced. An example of self-induced interest rate risk is a change in a business’s creditworthiness as a result of late on payments. or when their debt to income ratio changes. An example of an externally-induced interest rate risk is when the Federal Reserve changes its benchmark interest rate.
Inflation risk is where an investment in the business will not be worth as much in the future because of changes in purchasing power. A dollar today has greater purchasing power than the same dollar next year due to inflation. Therefore, investments that have a fixed return over a longer period have a greater inflation risk than ones with a variable return over a shorter period.
Governmental Business Risk Defined
Governmental business risks are where political events and outcomes can impede a businesses’ ability to succeed, or encourage businesses to take certain actions. Governmental business risk can be broken down into three types of risks.
Taxation risk is where new tax laws or new interpretations result in either higher taxes for you or lower taxes for your competitor. Governments are fans of using tax policy to preserve industries or to affect change. For example, your competitor may receive a tax credit because some of their power is generated from solar cells, which gives them a competitive advantage. Conversely, your business might be subject to a carbon tax, making your business less competitive.
Moreover, changes in the way taxes are imposed on a businesses’ profits or upon how capital gains are treated can encourage or discourage many different types of investments.
Filing taxes as a small business owner is more challenging than simply filing individual taxes. The tax cuts and jobs act recently made business tax filings even more complicated. Different tax rules apply depending upon your business entity type. Additionally, there have been changes to deductions. depreciation and expenses that can be claimed. Many new provisions have been added and in some states, the amount that can be written off for state and local taxes has been capped.
The US tax code is full of penalties too. Some common reasons the IRS charges penalties include, underpayment of estimated taxes, failure to pay taxes reported on an informational return, failure to file or missing filing deadlines, and errors due to negligence. Moreover, overlooking deductions can also result in a smaller refund or paying higher taxes. It’s always advisable to seek professional advice with respect to business taxes, and not be self-prepared as a way to prevent falling into tax-traps.
Compliance risk is where you break laws or fail to follow established federal, state, or municipal regulations. In many cases, compliance risk is due to simple oversight or human error and not one of deliberately or wantonly violating laws and regulations. However, compliance issues can cause legal liabilities for a business.
Compliance risk – also called regulatory risk – is not only something to be considered in large companies. One common example of a compliance risk might be that your industry requires an eyewash station for employees. Not having one, or not even knowing that you need one for your industry represents a degree of compliance risk. Another example of compliance risk is a product that does not adhere to properly established safety standards. One compliance risk I have personally witnessed is where a landscaper begins working prior to 8:00 AM and received a noise complaint.
Country risk is where doing business in a country that experiences negative effects associated with political events or with its economy. For example, you may make a product that you sell to another business, who then bundles your product into their product that they sell to China, and is exposed to tariffs in the trade war.
Have you considered your exposure to financial and governmental business risk lately, and devised a plan to deal with potential problems?