You can take the risks that your company faces and put them into two broad categories:

1. Operational risk. These are risks in terms of how well your company will operate.

Will you be able to execute on your business plan? Will you generate the kind of sales that you need? Will your cost keep within control?

2. Financial risk. This is related to the financial structure in your business.

How much financial risk are you taking on? In other words, are you very highly leveraged with debt? Do you have some safety room in your financial area?

You want to strike a balance between the two. If you have both high operating risk and high financial risk, you give yourself very little room to operate. If something goes wrong, you could be out of business very quickly.

So, if you have high operating risk, consider being more conservative financially. Don’t take on as much debt. Have more equity in place. Have more cash on hand in order to give yourself breathing room in case the operating side of the business does not turn out quite how you expected, including if it takes longer to reach your particular operating goals. Being more conservative financially will give you the capital and the time that you might need to turn the corner on the operating side. At that time, your operating risks will be done and you could consider maybe taking some money out of the business and being more aggressive financially.

If you have very little operating risk, you can consider being more aggressive financially. You might have low operating risk if you’re a fairly established company, you have recurring revenues and consistent patterns of profitability, and you know where your next meal ticket is coming from on a fairly consistent basis. In this case, you don’t need as much financial breathing room because you have a fairly good idea in terms of how your operating results are going to be.

You can afford to take on some financial risk in order to increase the return that your getting on the equity in your business.

Perhaps, another example would be if you have low risk in both areas, where you have a pretty stable operation and you’re very conservatively financed. This might not be the best environment though for getting a good return on your equity. If you have very low operating risks, you probably may not be returning quite as much in operating margins. And if you have very conservatively financed with high levels of equity, you’re not getting any leverage on the financing side. Take a look at your business in that situation and see what can be done to increase the returns on either side of the fence, operation or financial.

But, for most companies, there’s a bit of risk involved. Just make sure you don’t have too much risk going on on both sides of the fence. Keep it in balance and decide which risk you want to take on more of and which side to play it safer.

   

Jon Paul, MBA, CPA, CMC, CM&AA

President, Value Added Finance Resources
Bringing new insights on results and maximizing company value