The Bank Won’t Back Your Business Because You Don’t Have a Risk Management Plan

by Peter Kim/PMP, http://www.ProjectResearch.co.kr

Recently, I attended a business breakfast where the guest speaker, Dr Chris Caton, gave those in attendance his views on the global economic and market outlook for 2010. Dr Caton is a well-respected economist that works for the BT Financial Group in Australia. He told the story of a reporter that congratulated him recently for “calling the bottom” of the current financial crisis and the stock market downturn in a speech he gave a few weeks prior. He accepted the compliment, but informed the journalist that he had, in fact, “called the bottom” three times over the past few months, adding that he was more than happy with a 33% success rate for any of his forecasts. It seems that even the “experts” get it wrong sometimes, and more often than not when it comes to the volatile economic environment we do business in today.

So, now that we have reached the low water mark for the Global Financial Crisis (“GFC”), what have we learned? As a business banker, I can assure you that one key lesson learned by the financial services sector is that it is critical to have a Risk Management Plan for your business. If you doubt me, you could ask the brilliant financial minds at investment banking giant Lehman Brothers for their opinion on the matter. Rather, you could, if Lehman Brothers was still around to be asked. As has become abundantly clear over the past year, even the largest and most powerful companies in the world can be taken down by not properly assessing the risks they face in the day to day operation of their businesses.

Risk management has become the banks’ “topic du jour” in the past several months, and that trend does not look like reversing any time soon. So, if you’re looking to give your bank a reason not to back your business, you’d be hard pressed to find a better way to do so than by not having a risk management plan.

Show of hands – how many of you had a risk management plan in place for your business prior to the “GFC”? Or to put it in simpler terms, how many of you had an “early warning system” to help keep your business from going under in the face of multiple, unpredictable economic risk factors?

Those of you who did in fact have something like this in place – ask yourself: did it help avoid the worst case scenario for your business? If it didn’t, and you’re still alive and kicking or clawing your way back, now is the time to reassess your risk management plan, taking into account your key learnings from the whole debacle. That which doesn’t kill you, can only make you stronger (unless you ignore the threat and allow it to crop up again and again, bludgeoning you repeatedly until you slowly bleed to death). The key is to learn from your mistakes and put better plans in place to make sure the same mistakes don’t happen twice.

Now, for those of you who didn’t have an “early warning system” in place, two words: “GET ONE”. Or should I say, get one unless you no longer have a business of your own and have gone back to your old job.

So what, you might ask, is a risk management plan? A risk management plan is a written identification and assessment of the risks your business faces that includes an action plan laying out the steps you will take to mitigate those risks or the steps you will need to take if any of the identified risks actually come to bear on your business. A risk management plan takes into account not only your individual situation as a unique business entity, but also the risk factors that your industry, segment or market present.

These risks include, but are not limited to, such external factors as changes in market conditions, competition, economic factors like exchange rates and commodity prices, the failure of a key supplier or customer, regulatory changes or even changes in the tastes and fashions of the day. Some internal risk factors include poor management decisions, inadequate planning, incorrect finance structure, diversification outside your core competency or market and the deterioration of your reputation or product quality.

The list of risk factors could go on and on. The key to a good risk management plan is to consider the risks your business faces in terms of their individual likelihood of occurring and their potential impact on your business if they do actually occur. Analysis of this kind can be done best by doing what is called “scenario planning”, where you take into account the “best case”, “worst case” and “most likely case” scenarios and make a plan that prepares your business to handle each scenario with step by step processes to first avoid the risks faced in each scenario (think insurance or brand differentiation) and then to react to them in a controlled manner if they do in fact occur (think crisis response).

Why is this so important to the bank? Because if you have not addressed, in writing, the risks that are faced by your business, the bank will assume that you have not even considered these risks, or worse, that you foolishly think that your business operates outside the realm of risk. Make no mistake, the bank will identify the risks inherent in your business from their own perspective, but they are also looking to see if you have undertaken a risk assessment from your perspective in order to gauge whether or not your business is bankable.

One final thought on risk management plans. One of the most commonly overlooked risks to a business is the risk of growth – or more specifically, rapid growth. When a business is growing, there are usually cash flow risks (i.e. risk that the cash flow won’t keep up with the growth in sales volumes). Whether you’re introducing a new product or service, expanding the reach of your distribution network, setting up a new franchisee, or simply “turning it up another notch”, there is always the risk of over-trading, or growing more rapidly than the rate which is sustainable by your business’ cash flows. Think about it for a minute.

No one has ever, and I mean ever, given me a set of financial projections that project the business to do anything but grow. No one ever projects their business to shrink. Now, if you are going to predict growth, does it not make sense to take into consideration the risks involved in that growth? You’ve come to the bank to ask them to finance the growth you have projected, but how are you going to handle the growth without falling into the trap of over-trading? How are you going to plan ahead to make sure you are achieving the sales targets that are responsible for your projected growth? When the bank looks at the risks involved in your business, they are going to be placing much more weight on your projected figures than on your historical figures. That places even more importance on your risk management plan with regard to your projected financial results.

Who knows, without a risk management plan, your business could be the next Lehman Brothers. And trust me; you shouldn’t take that as a compliment.

The stress test will show you how relaxed you really are. Remember, the weakest link is YOU!