5 Ways to Help Mitigate Financial Risk

Financial risk management is an ongoing concern whether you're running a startup or a mature business. Mitigating financial risk, however, is not just about managing cash flow and preparing for rainy days. Your financial risk mitigation strategy needs to account for all areas of your business, from human resources to operations.

One common mistake that many businesses make is not treating their financial risk management as a continuous activity. While the annual budgeting process or an insurance expiration date are natural times for reviewing your risk mitigation strategy, it's a good idea to tie periodic risk evaluations to other business activities.

Here are five financial risk mitigation plan strategies that have worked for three successful entrepreneurs.

1. Evaluate business operations for efficiency.

Dorian Lam, a former management consultant, is now executive vice president at title insurance company Cornerstone Land Abstract in New York City. As one of the business partners, at least once a year he assesses the production workflow to understand where the costs are, especially in outsourced areas. Since the company's revenue is cyclical and depends on the real estate market – which means forces outside of his and his partners' control – he says it's important to hedge those risks that they can control.

“I deconstruct production, or the method in which the product is created, looking at parts individually and the sum of the parts to see if it's all happening in the most efficient manner," he says.

During his last assessment last year, Lam discovered that Cornerstone Land Abstract could save about 50 percent of costs by purchasing its research data and hiring someone to synthesize it in-house, rather than outsourcing the entire process. In addition to cost savings, the discovery led to a new revenue idea.

“We took the opportunity to hedge our risk by creating a new income stream," he says.

He recommends a process that begins with an organizational chart and an employee roster, then breaking the workflow into a detailed checklist, from order intake to client delivery.

2. Nurture your talent – and outsource where it makes sense.

In a customer-facing business, employee turnover can directly impact the bottom line. Gabriel Shaoolian, who grew his digital media agency Blue Fountain Media from zero to 250 employees before selling it, said losing employees was his biggest risk.

“When you have someone managing an account, when they leave, the client confidence gets shaken and you can lose that client," says Shaoolian, who founded a new startup in 2018 called DesignRush, a marketplace for companies to hire agencies (vs. individual freelancers).

With his previous agency located in New York City, he says it was especially challenging to compete with other technology companies.

“If you have good employees, they're constantly being approached," he says.

With DesignRush, Shaoolian took a completely different tactic. Instead of opening a physical location and hiring employees, the company is entirely virtual and operates with consultants and vendors.

“One way to reduce risk is to not hire people full time if you don't need to, lowering overhead," he says.

Nurturing employees is another way to mitigate the turnover risk, Lam says. The talent pool for people trained in land title insurance is limited, so his company is especially focused on knowing the employees' concerns and providing growth opportunities. For example, employees can take an hour every week to research something they're interested in learning.

“It's our responsibility as partners to make our employees feel safe, give them something to be passionate about and allow them an environment where they can continuously learn," he says.

3. Create a strong foundation for your HR practices.

An often-overlooked risk management area includes employment practices, says Frank Costa, a certified risk manager and certified insurance counselor with 30 years of experience in the industry. Costa, who is the chief operating officer for World Insurance Associates, LLC, in Tinton Falls, New Jersey, had previously owned an independent insurance agency. He says the company's relationships with its employees create financial risks such as litigation for wrongful termination, harassment, and discrimination.

“Everyone wants to believe their company is like a nice little family, but there's potential financial risk that can be a significant drain on resources, create high legal expenses, and have an impact on corporate culture and productivity," he says.

It's our responsibility as partners to make our employees feel safe, give them something to be passionate about and allow them an environment where they can continuously learn.

—Dorian Lam, executive vice president, Cornerstone Land Abstract

To manage that financial risk, Costa says it's important to have a strong foundation that includes a multitude of best practices.

“You need to have strong human resources practices and procedures, including an employee handbook, harassment training, and education; and company leaders must be present in terms of relationships with employees and be sensitive to their needs," he says.

4. Use metrics for every decision.

It's not enough to use metrics to measure business performance. Shaoolian says every decision needs to be measured ahead of time.

“I learned quickly not to make a move unless I can measure it," he says. “You don't throw a client event unless you know exactly what you want to get out of it. You don't hire someone if you don't know exactly what you expect them to produce. If you can't measure a decision, you shouldn't move on it."

Sometimes the metrics are qualitative rather than quantitative. For example, when Shaoolian looked at cutting expenses, he would not lay off employees to save money.

“I was always careful about cutting people – when you cut someone because you're having financial difficulties, that lowers the morale of the team and they fear job insecurity," he says.

5. Be prepared to cover a loss.

When the unexpected happens, whether it's a supplier factory shutdown, a cybersecurity incident or an employee liability claim, you need to know how you'll pay for a major loss.

“If you have a strong risk management plan and have identified your risks and ways to control them, part of the plan is how you'll finance the risk. You need to decide if you're going to finance it through your savings and retained earnings, or if you want to finance it through an insurance policy," Costa says.

Besides the foundational insurance coverage that is mandatory or required by client contracts, decide what optional insurance makes sense based on your industry and business characteristics. For example, Costa says, an employment practice liability policy would not be a high priority for a small business with three employees, while a restaurant with 300 employees, high turnover, and constant public interaction may want to strongly consider it.

He cautions that insurance is not a risk-transfer mechanism.

“The company is still at risk. The difference is, if there's a loss, who pays for it," he says.

Insurance is only one piece of financial risk management, and you still need to have all the best practices and procedures in place to mitigate the risks.

“Insurance is not the answer to everything," Costa says. “It's an important tool and a part of your overall strategy, but not a silver bullet."

Frequently Asked Questions

What is financial risk mitigation?

Financial risk mitigation is the management of risk to decrease it by reducing risk factors or eliminating them. In doing so, a business hopes to avoid financial ruin.

How do you develop a financial risk mitigation strategy?

Small businesses can develop a financial risk mitigation plan by first identifying the risks. Then, businesses will need to take steps like securing insurance policies, building an emergency fund, and diversifying income sources to dilute the power of identified risks. 

Why do you need a financial risk mitigation strategy?

Every small business needs a financial risk mitigation strategy to help limit the impact of threats to the business. By identifying and mitigating risks, businesses have less of a chance of being negatively financially impacted by future threats, whether internal or external to the company. 

A version of this article was originally published on March 15, 2019.