Managing risk, managing the recession

Richard Walker Richard Walker

In recent weeks, our country has slipped into a recession with our GDP down 0.7% in the first quarter of 2017. Coupled with the negative outlook from the three major rating agencies, consumer, business and investor confidence has hit an all-time low. 

Risk management can help to navigate turbulence

In turbulent times, a robust risk management system should include mitigating action plans that will reduce the impact of a recession and ultimately ensure the business remains liquid experiencing as little damage as possible.

The business needs to question if it can still target growth given harsh economic realities and may instead need to maintain a holding pattern. This does not mean business should become reactive to simply survive, but rather, a holding pattern requires the business to take a step back and determine what effect the recession will have on the company and then adapt its strategy accordingly.

Taking a step back is in fact a proactive approach and provides an opportunity to improve or change the business outlook. It is advisable to look a little deeper at the business’ customer base as it may be time to consolidate so as to better service higher margin or larger volume clients.  Business needs to remain agile during these periods of uncertainty. Having a robust risk management system will assist in ensuring that agility leads to business success and averts potential business failure. 

Risk management ensures working capital agility

A robust risk management system would ensure that the business has an adequate working capital management program in order to retain its credit profile and maintain solvency. It is important to recognise the need for change in the working capital strategy as the objectives of the business change.

In a business faced with the risk of poor sales due to a downturn in economic conditions, the mitigating action plan might be to move from a conservative towards a more aggressive working capital strategy. For such a business, an objective of 30% return for investors would not be achievable and its objectives may need to change in a holding pattern strategy to maintain current revenue. This change in the business objective would likely result in a change in the working capital strategy.

Robust risk management and stress testing aids business resilience

The working capital ratio determines the financial health of the business and depending on the industry, a current ratio of between 1.2 and 2.0 would indicate a financially healthy business.  However, within a robust risk management system the mitigating actions are stress tested to determine the overall effect once implemented.  A business experiencing lower demand would stress test the working capital ratio against the business’ desired holding pattern result to determine the precise working capital ratio which may lean towards being more aggressive at 1.2 to 1.4, or more conservative being 1.8 and up. Only stress testing would provide the ideal ratio.   

Should the initial stress test results show that the business needs an aggressive working capital strategy (such as to sweat its assets by increasing the business cycle in order to maintain revenue and maximise inventory management) this would come with specific risks that would need managing to ensure the new business objective is achieved. Such risks could include inventory shortages and ultimately loss of sales which would lead to suppliers being impacted as businesses necessarily extend credit terms which in turn could then result in “cash-only” policies needing to be implemented or non-delivery of raw materials. A robust risk management system would identify these risks at an early stage and the business would be able to apply mitigating actions, like ensuring suppliers are kept informed of their new business objectives and working capital strategy, so they too are able to change their business objectives.

Managing risks to ultimately return to growth

A robust risk management system could ultimately assist businesses in challenging times, increasing agility, ensuring resilience and, in time, a return to growth.

For more information on how you can implement risk management in your business, please contact us.