The advent of the digital age has blurred the lines between global and local and changed the very nature of business. Additionally, with ever evolving economic conditions, Small and Medium Enterprises (SME) in particular are facing increasing limitations and business complexities that make it imperative for them to put in place strategic and tactical systems to minimise financial risk.
This is important more so because of a wider economic slowdown, which has increased the need for transparency and driven decision makers to take a closer look at internal controls and compliance policies. Business challenges also require that an internal audit function goes beyond just fulfilling compliance, and strategically contributes to business performance.
But, before organisations can start thinking of effectively managing this risk, it is important to understand the different types of corporate threats they could face. Broadly speaking, companies may be held liable for risks including credit, operations, market and liquidity, trading and transactions, governance and compliance.
Tackling financial risk
Financial risk is inevitable for modern-day businesses, especially as increasingly demanding market conditions and tighter lending requirements by financial institutions, growth aspirations and requirements compound the challenge of managing this risk. Exposure to financial risk could make companies more vulnerable if adequate risk management and governance principles are ignored or delayed.
By identifying and efficiently managing risks early on, organisations can establish a framework that will make tackling and preventing potential threats easier, allowing more time to concentrate on core business and improving profitability. More organisations are recognising the benefits of a coherent approach to financial risk management. Many are also seeking to use risk management and good corporate governance culture to drive performance.
One of the key areas for companies to manage financial risk is effectively juggling relationships with suppliers, customers, lenders and shareholders. Each of these has a significant influence on a company’s decision-making process and can be better managed when governed by a reasonable set of controls. A robust risk management framework gives organisations an edge in meeting shareholder expectations, gaining investor confidence and capitalising on growth opportunities.
The mission for SMEs
In the UAE, developing the SME sector is one of the top priorities for the government and, therefore, it is essential that these companies have appropriate guidance on how to build businesses that are equipped to take on financial risks that come with growth.
At KPMG, we recommend the following ways for SMEs to manage financial risk:
1. Defining a corporate governance structure: The next step is to identify and establish a degree of governance over the company’s operations. Not only does this help maintain an oversight on business functions, it also builds the image an organisation wants to send to its customers as well as shareholders.
Establishing a board of directors is one way in which companies can build corporate governance. UAE law doesn’t mandate a board for SMEs comprising of independent non-executive directors, but having independent figures (separate to the owners) evaluating and endorsing business decisions and preventing any major pitfalls is an advantage. When evaluating a company’s spending on corporate governance, at KPMG, our advice is to view this not as a cost but as an investment into building investor confidence.
2. Tie-up with an independent adviser: While almost all small businesses start out with a combination of entrepreneurs and investors, it is important that they also factor in an independent adviser to exclusively handle governance and internal controls. This will ensure that a risk management system is built as the organisation grows and is, therefore, integrated with the core business set up.
An independent adviser has a thorough understanding of the macro environment the business is operating in and will be able to support management in modelling the system to withstand market pressures and focus on future growth.
3. Managing liquidity: Having a clear picture of how much cash organisations have access to before making investment decisions is an effective way of minimising liquidity concerns. The cost of borrowing is quite high and as an SME, the organisation should restrict the number of lenders they seek financing from. It is also recommended to have adequate controls in place and closely monitor where borrowed funds are being used.
4. Managing credit risk: An ongoing assessment of credit risk creates an early warning system that enables organisations to effectively manage their receivable portfolios. For such an assessment to be effective, it is important for companies to integrate the three phases of the credit risk management framework — initial assessment of the risk, ongoing reassessment, and exception reporting and monitoring.
5. Building customer relationships: An organisation that cultivates brand loyalty among consumers is at far less risk of losing customers to rivals. Companies that are increasingly investing in gathering data to analyse information on their customers’ preferences and spending patterns are likely to enjoy significant competitor advantage in the future.
Identifying and effectively managing financial risk is not the function of any one department in an organisation. In order to efficiently protect the business, it is important for the practice to be absorbed into the day-to-day running of operations with accountability spread across different departments. This will enable companies to take optimal advantage of growth opportunities while minimising business risk.
Harikrishnan Janakiraman — Director, Consulting, KPMG in the UAE
