To be able to fight risks better, it is first important to identify them so that a strategy can be prepared. Given below are some of the most common risks that every small business faces. Since most of them cannot be completely removed, it is important to take steps to at least minimize them.

Risk of Big Businesses Entering

One of the biggest risks that small businesses face is the danger of a big company overtaking them. It has happened several times in the past where a small business was overtaken by big corporations.

A simple way to stay away from this is to not compete with big businesses and draw the lines where they should be drawn. Small enterprises should try to grow without trying too hard as they can hardly compete against the big giants.

Risk of Spending Too Much

Small businesses cannot spend too much on anything. Since small enterprises have limited resources, they must make sure to use them carefully so that they do not get in any sort of financial trouble. They need to have their boundaries set correctly and spend within the limits.

They should stay away from going loud with promotions and other activities as such a step may backfire.

Risk of Failure

Every business faces the risk of failure. It is something that cannot be controlled completely. You never know how people will react to your product and if they will accept it with open arms or if it will be rejected.

The best solution to minimize this risk is to start a business after doing a good amount of research so that the risk of failure is minimized. Once you are aware of what the people really want, you will find it easier to provide them with it. And when people get what they want, the risk of you going out of business will be minimized.

Risk of Running Out of Finance

It is death for a business if it runs out of finance. There are several reasons why a business may run out of finances, such as overspending or failure of a product or idea. This generally happens when business ends up calculating things incorrectly or spends too much on something.

When a business runs out of finance it either shuts down or looks for loans that often proves to be a huge mistake. Businesses should always avoid excessive debt as it may result in several major problems that can be difficult to overcome.

Every small business owner should try to minimize all the risks mentioned above. The best practice is to identify risks as early as possible and find solutions to them so that a business can continue to grow.

The risks that are due to the factors that are under the direct control of the business are called controllable risks.

Most controllable risks are internal risks that arise from the business itself. It happens because at times the business is not able to conduct properly, and has to face several problems.

Since they are mostly related to the business itself, it is easy to control them – hence the term, controllable risks. However, at times, it becomes very difficult for businesses to control risks for various reasons.

A good example is of operational risks that are related to the day-to-day operations of a business, such as small financial risks. Since there are numerous things happening in a business, it is often very difficult for managers or directors to keep an eye on everything and manage it on their own.

This is where there is the need to have risk units that can look after everything and manage it. Several big companies have big risk units with people who specialize in recognizing and controlling risk.

The biggest, and often the most difficult, task is the recognition of the risks associated with the business. If one is able to recognize the risks in advance, then it becomes easy to control it, because the business has direct control over them.

Uncontrollable Risks

Uncontrollable risks, as the name suggests, are the risks that arise due to the factors that are not under the business’ control.

They are considered important because a business has to plan very carefully regarding everything, keeping in mind the fact that they cannot control such risks, and that these risks may have a major impact on the business.

Some major uncontrollable risks are:

-   Economic Conditions

-   Political Instability

-   Changing Technology

To understand this clearly, take an example of a business, which after seeing the need and demand for a product decides to launch it in six months after a good amount of promotion. However, before it could launch the product, the technology changes and the product becomes obsolete as a better substitute is now available in the market. What will the business do now? It will have to suffer from a loss!

This is a huge risk that has to be controlled. In this case, the best practice is to do a good amount of research and keep all the uncertainties in mind, when planning. There are several research organizations that can help companies in this regard. They can prepare a prediction chart and what-to-expect from economical or political environment in the near future.

Businesses also have to keep an eye on competitors and make sure that they stay ahead in the competition. Another good option is insurance that can guard a business against several types of risks. It is also very important for businesses to have a contingency plan for both types of risks, as a bad situation can arise at anytime.

Evaluation of risks associated with business is a must for all financial institutions. This especially refers to banks that have to make sure that the business or company they’re investing in will bring back their invested money along with interests. Businesses that are unable to return their loans on time affect the bank’s credit rating directly warding off possible future investments by outside companies.

A bank needs to keep its investors and borrowers in line keeping the flow of cash regulated. Otherwise if there are times of financial crises in the economy and people would want to take out their investments, the bank will not be able to pay up leaving every one of its associates in distress.

Risks surrounding the markets on a national and international level also have a considerable impact the policies of financial risk management set by a company or a business. The circling of goods or commodities on prices assigned by the market makes a direct impact on the sellers’ profits and losses.

Currency risks are also associated with the international market as countries trading with their own currencies are more liable to the global monetary value drifts. Therefore, some countries prefer to trade upon gold as its value is less likely to change quickly on global scale.

Every company or business is bound to go through audits if they are not careful in managing the flow of income and savings earned. Audit risk of a company or business is determined by the multiplication of inherent risk, control risk and detection risk. Hence, audit risk = IRxCRxDR.

A lot of things can cause loss or disturbance to your company’s profits. For example, there’s no telling of when a natural disaster may wreck your area or a harmful gas leakage that could cause permanent and fatal implications for your employees and nearby residents.

Therefore, it is imperative that a company or organization maintains its risk management policies. Be it impending natural disasters or faulty product ingredients, an organization should always be ready to take on the prospectsof failure or damage.

Here is when risk management comes in. With it, you can avoid huge losses and limit your damage to a minimum. This involves the cataloging, classification and assessment of possible impendence.

Once you know how much your company is liable to damage, you can get an estimate on that damage. Now the estimate will differ in accordance to the people or employees inflicted with the hazard that has struck your organization.¹

There’s not much you can do in events of natural calamities. However, you can make sure that your structure is disaster proof, i.e. using building material that is more resistant to natural elements.

If your company’s image is ever at risk by accidental supply of faulty products in the market, you can also use the social media and particular social network forums where your representatives can give an explanation or apology on behalf of the organization.

By simply studying the scenarios involving risk management and doing case studies on other organizations that have gone through hazard, some eventually avoiding it, you can save your company or organization from a great deal of unwanted bad publicity.

Every company has its own financial risk management system in order to face the different types of risks and the hazardous situations associated to them. If this strategy is not made and implemented, the company can suffer huge losses. Whether it is the risk associated with frauds from customers or changes in the business environment, the company must make proper risk management strategies to counter it.

Financial risks are usually those related to stocks, commodities, interest rates and bonds; they are also usually faced by multi-national companies, joint stock companies or financial institutes.

This type of risk is associated with the company’s inability to meet liability or equities such as accounts receivables, notes receivables, etc. For example, if the company has provided loans to several small businesses in the area and 10% of them are incapable of paying back that amount, the company will suffer losses. For such losses, the credit risk management makes necessary strategies before providing loans. The bad debt expense account is one such example.

Market risk is simply defined as the loss expectations a company keeps. These expectations are related to the price fluctuations and the firm’s investment. Here’s an example – a company invests $10,000 to make 100 products; thus, the company decides that the best price for each of its products is $1000. However, the company later on may realize that due to the fluctuations in the market, the product price should be kept $500 or else the company won’t be able to get customers. For such situations, the company creates a market risk management strategy beforehand to counter these problems.

Currency risk is also known as the foreign exchange risk. It is the loss expectation that can occur because of the adverse fluctuations in the currency rates. Companies which are directly involved in trading with currencies prepare a currency risk management strategy to counter these situations.

The country of the industry involved is the key factor that differentiates the concept of domestic and international lending. Country risk encompasses every form of risk and uncertainty arising from political, economic and social conditions of the country. These factors can lead to constraints for the industry, preventing it from fulfilling its obligations to international clients. As a result, the pressure on people implementing best practices increases.

In addition to the above risks, it is also likely that country risk may result due to expropriation or nationalization. Moreover, exchange control, devaluation of currency and government repudiation also contribute to country credit risk. As a result, constraints on decision-makers of the company increase. To ensure best practices for risk management, they are forced to refrain from delivering the goods across border. Instead, they resolve to trade within the country to mitigate losses.

However, the plus point here is that country risk is one that industries can influence directly. International companies, therefore, must ensure that they utilize adequate technology and systems to manage cross-border exposure. In order to ensure risk management, CEO’s should concentrate on best practices to avoiding risk in the first place.

The success and sophistication of risk management systems implemented depend on the complexity of cross-border exposure.

Forms of Country Risks

International companies are liable to exposure to six main forms of country risks. These include:

• Sovereign risk: This denotes the willingness and capacity of foreign governments to repay direct or indirect financial obligations. These are usually in foreign currency.

• Transfer risk: This form of risk denotes the inability of a borrower to obtain foreign exchange to be able to fulfill external obligations. This often happens because of social, economic and political problems. The consequence of which is drained foreign currency reserves of the country. As a result, borrowers cannot convert local currency funds to foreign currency.

• Contagion risk: This risk results when adverse conditions of one country cause negative impact on the credit of other countries in its region. This can happen regardless of whether neighboring countries are credit worthy or not.

• Currency Risk: This is a risk associated with the probability of cash flow and domestic currency reserves becoming inadequate, due to devaluation.

• Indirect Risk: This is when the ability to pay cross-border is endangered due to economic, social and political reasons.

• Macroeconomic Risk: When interests go high due to failing economy, the borrower’s risk increases. This leads to constraints in best practices for international businesses that cause increase in country risk.

Therefore, it is country risk management that is important, as far as country credit risk is concerned. Banks plan an important part in this and must implement the best risk management strategies.

According to IMF data, over the years the figures for outstanding global credit derivatives have increased drastically. Therefore, it has become a challenge for financial institutes like banks to monitor financial stability.

Banks are the forerunners in the market. They transfer substantial credit risk to individual participants in the market. The instruments they implement in order to achieve credit transfer are complex. Sometimes, understanding risk-returns becomes impossible without restructuring the system. A reference portfolio is also required in most cases.

To achieve compliance with requirements for monitoring credit risks, three best practices are recommended. These are:

Individual Transaction Risk

A systematic financial approach ensures security and a better financial-return. You have to think about what kinds of risks are associated with any individual transaction. You also have to evaluate who will face the consequences of the associated risk. The data required for this practice is very demanding and challenging. For best practices and proper data assessment, the following information about individual security is required:

• Type of Asset
• Worth of Each Asset
• The Credit Associated with Individual Assets
• Expected Rate of Financial Recovery

If these requirements are not fulfilled, managers can use a reference portfolio for reference. This is an effective best practice that helps issue timely financial reports. Besides this, one can also include compliance with new security protocols. This will help establish a reliable portfolio and standards that investors can follow. Moreover, this will guarantee quality, rating coverage, diversity, obligator concentration, standard security rate and standard recovery rate.

Individual Bank Risk

After individual transaction risks are identified with best practices, it is important to monitor the impact of certain transactions on the risk position. This has a direct impact on financial institutions like banks.

There are two effects of individual transactions on individual banks that must be considered:

1. Does the bank take risks associated with financial transfers?
2. Does a transaction alter the bank’s leverage on default probability?

Note: The second scenario may occur if securitization proceeds are utilized for debt holders or to pay equity. It is also likely to occur when payments are in portions other than what was previously agreed.

Systemic risk

After risk assessment is successfully completed through compliance, systemic risk evaluation follows. There are mutual interactions between investors and financial institutions that must be observed. It is important to determine who takes the systemic risk. Besides, you have to assess whether the risk is transferred outside to other financial sectors.

These best practices involved in monitoring credit risk provide a clear understanding about credit risk transfer and financial stability.

Importance of the Gear Ratio

The figure obtained as the gear ratio is helpful in comparing the liabilities of the company in relation to the total capital. It provides companies the opportunity to review their dependence on debt financing that is usually external. In simpler terms, it defines the risks associated for stakeholders to be able to implement best practices for risk management.

Knowing the gear ratio also allows business owners to know their borrowing capacity. This is a recommended best practice that enables risk management to a great extent. This information also assists in best practices related to scheduling financial payments to settle the debts and leases. The debt/capital ratio is a best practice tool for analysts and bond rating companies to evaluate the creditworthiness of the company.

Assuming that the lowest value of gear ratio is the best achievement is a mistake and goes against risk management. This is what misleads most companies into taking larger loans to expand their business. Usually utilities that have higher capital requirements will have a higher gear ratio. Therefore, those companies that develop or manufacture new products or technology tend to have a higher gear ratio. This not a recommended best practice. It is important to mention that companies with higher debt must have positive earnings and a steady flow of cash to ensure risk management.

Calculating the Gear Ratio

There are many approaches for calculating the gear ratio with best practices. However, the most common approach is to divide the sum of liabilities (or the long-term debts) by the sum total of assets. The sum total of assets is obtained as a sum of the liabilities and funds of the stockholders.

This is illustrated in the following mathematical equation:

Gear Ratio or debt/capital ratio = Sum of Liabilities ÷ Sum Total of Assets

An Example of Calculation

Let us assume that the balance sheet of a company reports the total liabilities as $10,000,000 and the total fund of stockholders as $13,000,000. To ensure sufficient risk management it needs to know their gear ratio. The gear ratio or debt/capital ratio will be calculated as follows:

10,000,000 ÷ (10,000,000 + 13,000,000) = 10,000,000 ÷ (23,000,000) = 0.434. This can be expressed as a percentage by multiplying it by 100. Therefore the gear ratio will be reported as 43.4%.

Other approaches to calculate the gear ratio separate the different portion of the total of liabilities. However, for best practices this approach is not ideal because it becomes too complicated. Most experts consider those steps of the calculation as pointless. Some business people actually prefer to divide the total liabilities by the total funds.

Whichever approach one takes, the outcome is usually the same. However, ensuring that there are no errors is recommended and therefore sticking to simpler formulas is the ideal best practice.

Sovereign debt is a riskier investment than public debts (in some ways). This is the case in developing countries, and is more risky than in developed countries. The political, economic and social stability of the issuing country’s government is an essential factor. These factors must be considered while assessing the risk of investments. International and national investors evaluate sovereign credit rating to measure the extent of risk involved in investments.

Public debts play a significant role in the economy of the country. It is a high credit investment that has a high percentage of liquidity. The US treasury market clearly illustrates this situation. Consequently, sovereign borrowers are expected to comply with risk management best practices. The practices and regulations involved in risk management reflect the preferences of the government. Moreover, companies involved in financial markets (at an international level), have to abide by and fulfill responsibilities that represent the government. For companies in the US, this becomes a bigger challenge because the highest level of reputation has to be maintained.

As a best practice for risk management, there are clear orthodox guidelines and government objectives set by countries in the financial market. These objectives are based on targets set for annual inflation. However, the greatest challenge is that government objects are unclear in terms of risk associated and costs. In most countries in the United States, debt management policies are implemented without in-depth insight into risk tolerance and preferences.

Countries enlisted as members of the OECD (Organization for Economic Co-operation and Development), recently took positive initiatives. They recognized the shortcomings of sovereign debt and addressed the problem. Each country established an independent debt management bureau. The sole responsibility of this office is to ensure public /sovereign debt risk management.

IMF’s Stand on Sovereign Debt

The International Monetary Fund (IMF) has started taking serious interest in sovereign debt management. According to the IMF the definition of sovereign debt is more concise. It is as a process that establishes and executes strategies to manage government debts. The objective of this is to raise required funds to settle the debt.

Therefore, greater challenge is to meet the objective (government debts) at the lowest possible cost. The IMF has therefore presented a framework for countries in the United States to help achieve the objective. This IMF framework is aimed at assisting debt managers to control and identify trade-offs between risk and cost.

Why is Sovereign Debt Important?

It is important because it outlines the performance and achievements of any government. It generates information about substantial risk to the country’s balance sheets and its financial stability. Therefore, through best practices for risk management, funding, liquidity, credit and exposure to markets can be managed.

Therefore the role of the IMF in US sovereign risk management is very important for the future of US economy.

The government must ensure compliance with policies. For example, public debt is sustainable when there is a balance in the rate of growth of the government debt and the level of debt. At the same time, through best practices cost and risk objectives can be met. There are indicators which must be implemented to address the issues related to government debt. Indicators include public sector – debt service ratio, ratio to tax revenue and ratio of public debt to GDP.

Failure to ensure best practices in public debt management lead to a poor system. This means poor management of maturity, currency, interest rates and unfunded contingent liabilities lead to escalating economic crisis in the country. There are numerous examples in history where this has been witnessed. Irrespective of the extent of debt, exchange rates and domestic currency, economic crisis is inevitable because the government begins to focus more on possible cost saving options associated with floating rate debts. This leads to exposure of the government budgets to changing financial market conditions which affects the creditworthiness of the country’s economy. Therefore as a best practice, reducing the risk through effective management can make the country less susceptible to financial risks.

Debt market crisis reflect failure to ensure compliance with best practices for financial risk management. It is an essential best practice that public debt management practices should be implemented to ensure efficient capital markets. There may be times when government debt management policies may not have been the main cause of poor public debt management. Other factors which may have caused this include poor maturity structure, poor interest rate and poor currency composition of the government debt portfolio. All of these causes can be avoided effectively through compliance with best practices to ensure efficient risk management.

Another cause of poor management of public debts is the risk debt structure. This situation arises due to inappropriate economic policies, fiscal and monitory rates and exchange rates. It is important to realize that macroeconomic policy settings affect government debts. If best practices are not ensured for macroeconomic policy settings there may be server economic crisis. Having sound debt policies as a best practice reduces country’s susceptibility to financial risks. It serves as a catalyst in improving financial market development and turns it into a stronger establishment.

Best practices in public debt management are important to ensure economic stability in the country. This is important for business growth in the country as a whole and compliance with best practices must be emphasized at every level to ensure adequate risk management.