Failure of risk management contributes to insolvencies

It’s well known that Australian SMEs play an integral part as the backbone of the Australian economy and yet, the struggle for sustainable growth continues to plague business owners. On one end of the scale we have a multitude of SME support, helping entrepreneurs with marketing and monetary advice for their start-up ventures, and on the other end of the scale there are insolvency practitioners that specialise in voluntary administration to try and turn a failing business around. Though at this point, the reputation and perception of the business is already scarred and new owners or customers may be scared off.

At the end of the last Financial Year, ASIC’s report on corporate insolvencies highlighted SMEs to be the dominant player several years running. The report provides further insight as to the top 3 nominated causes of failure for SMEs, namely inadequate cash flow or high cash use (41%), poor strategic management of business (37%) and trading losses (33%). With seemingly no clear middle-ground support for SMEs, one of the solutions worthy of consideration is to prevent, protect and support the counteraction of these causes of failure by implementing risk management strategies.

What is risk management?

In general terms risk management is about identifying potential business threats, mitigate the risks by understanding how the threat is likely to eventuate and impact the business, then implement a procedure that allows for monitoring and resolving the risk if the latter arises.

This very process can be a matter of life and death for the SME. Having a risk management strategy in place can have an enormous impact in the reduction of insolvencies and voluntary administration. Specifically, financial management is an aspect that SME owners take less interest in unless they’ve had previous knowledge and exposure to this as part of their professional experience. Despite this lack of knowledge it may be said that the onus is on the owner to educate themselves and seek appropriate advice. However, often for sole traders and small companies this is de-prioritised in the spirit of keeping up with the ‘real’ work to keep customers happy.

Inadequate cash flow or high cash use, poor strategic management of business and trading losses can be incorporated in the following key aspects of the accounts receivables function of a business:

• Create a Credit Policy that clearly states terms of trade (i.e. credit terms and credit limits)
• Ensure that credit applications are in place and completed in full for all credit customers
• Create Terms & Conditions which should outline your terms of trade
  • Always make sure that a legal professional prepares the Terms & Conditions since it forms the legal platform for the relationship between the Buyer and Supplier
  • Some key clauses to protect a business include:
    • Payment terms / invoicing – enforceable through your collections procedure and backed up by a credit policy. Use it consistently, so that customer knows that no further supply occurs until the account is up to date or within the approved credit limit
    • Personal Property Securities Act / Consent to register
    • Jurisdiction (court jurisdiction based on the size of the debt and place of business undertaking)
    • Legal recovery process
    • The Buyer is liable for its own legal, account and business costs as well as the Supplier’s costs and disbursements which are incurred in pursuing settlement of the debt
• Create procedures for collection of overdue accounts and maintain consistency in enforcing credit terms
• Invoice on time and monitor accounts consistently to get paid on time

Although the above does not cover the entire spectrum of strategic and risk management, it certainly places the business owner in a much better position to focus on growth and take control of their cash flow. And being able to focus on growth, trading losses may receive the required attention at no expense to the financial side of the business.