With many businesses closing their doors due to ongoing pressures caused by the COVID-19 pandemic, those who are left are intensely aware of the importance of reducing their own risks for their business. Frank Lo Pilato, partner and director at RSM Australia, explains the four most important risk areas for small business owners to focus on.
The coronavirus crisis has put enormous financial pressure on millions of the nation’s small business owners. There’s little doubt that despite government assistance, small businesses that face cash flow problems or debt recovery issues often can’t continue operating for very long under these conditions.
However, it is possible to reduce the chance of business failure by taking a few simple, risk-reducing steps. Business failures happen when owners act too late.
4 ways to reduce your business risk
1. Reduce risk as a supplier
If a business depends on a handful of major customers, just one customer who fails to pay can have a dramatic effect on cash flow.
It is therefore imperative to reduce the risk of bad debts by understanding whether customers are paying on time and within payment terms. It’s also important to know if customers are paying with debt-factored finance, which can indicate cash flow problems that may affect their future ability to pay. Business owners should limit credit for customers who aren’t paying within the invoice terms.
Small business owners should, where possible, check on customer circumstances; if they’re not getting paid by their customers, they’re unlikely to pay their own suppliers. They should also register interests with the Personal Property Securities Register (PPSR), which is the only way to recover goods if a customer’s business fails.
Owners should also seek a formal credit agreement with business partners, preferably with a personal guarantee from the business owner, making it possible to recover debt from the owner personally.
And, of course, it makes sense to spread the risk across more customers wherever possible.
Click play (above) to hear great cash flow tips for your small business
2. Reduce risk as a customer
Businesses usually rely heavily on other businesses to supply goods that let them provide their own goods and services. If a key supplier fails, this can make it difficult or even impossible to continue as usual.
To reduce the risk of not being able to deliver, businesses should identify potential alternative suppliers of essential goods and services.
3. Reduce personal risk as a guarantor
Some small business owners become personally exposed if they act as a guarantor of other people’s debts.
To reduce these risks, business owners should avoid guaranteeing the debts of anyone else without being fully aware of the limits of the potential liability if they don’t pay – including understanding what they risk if the debt goes unpaid. They should also insist on written agreements, even if guaranteeing the debts of a family member, and seek professional advice before signing.
It’s important for small business owners to only agree to be a director of a company if they intend to participate fully in all decision-making processes, because directors can be personally liable for company debts. Ignorance is no defence.
4. Reduce risk as a small business owner
Small business owners can be personally liable if the business fails, potentially leading to individual bankruptcy, even if they had no idea about problems in the business.
Therefore, it’s essential for them to arm themselves with full knowledge and awareness of all company activities, especially regarding the accounts.
Small business owners must keep accounts updated and query any abnormalities. They need to be aware of factors such as the availability of working capital, alternative finance sources, emergency plans if customers fail to pay, and whether all payment obligations are up to date, including promptly lodging all tax statements and payments. Understanding your financial obligations also includes being aware of any off-balance sheet obligations such as long-term property leases.
If the business can’t service its debts, it can go under very quickly. When that happens, business owners may find their personal assets – including the family home – could be at risk. It’s therefore important to check the fine print of any credit applications and seek professional advice before committing to any finance agreements.
Small business owners should be fully insured and conduct adequate checks to ensure staff members are capable and trustworthy.
Knowledge is power
Company directors including small business owners have a clear obligation to be aware of the company’s financial circumstances, and are liable to insolvent trading claims by liquidators.
Knowledge is power, because there are usually plenty of warning signs that a small business could be on the brink of failure.
Sheer bad luck can contribute but, with so many ways to protect against the risks of insolvency, business owners need to stay informed. Identifying the warning signs early and acting fast can mean the difference between going out of business or continuing to grow and thrive in the long term.
Small business owners who aren’t sure where to start should get advice from a trusted professional sooner rather than later. A business advisor, accountant, or solicitor will be able to provide specific advice that relates to the business’s unique circumstances.
This post was originally published in 2017 and has been updated for 2022.
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