Risks to Profit
June 8, 2009, 6:20 pm
Those things that can limit, reduce or eliminate profit.
The focus of this article is on those events and situations that put profit at risk. What could hurt long-term profit? Anything that shrinks margin, makes profit turn negative (a loss) or is so devastating that the organization goes out business.
Risks to business, like dangers in life, can come from just about anywhere, at differing speeds and with or without warning.
In a financial sense, risks can attack:
1) revenues, causing them to decline (either absolutely or by reversals)
2) expenses, causing them to increase (either through normal operating costs or one-time hits)
3) assets, causing them to lose their value
4) liabilities, causing them to increase, and
5) capital, including the ability to raise additional funding
In a business sense, risks can attack customers, products, the market, the industry, your associates.
Risks are ubiquitous and an intrinsic part of any business. They can’t be eliminated. However, they can, and must be anticipated and managed.
Tracking fundamental profit risk
Many risks to the profitability of a company are easily identifiable, and insurance may be bought for the more common ones (e.g., fire and theft insurance; interest and foreign exchange movement hedges).
Some risks may be teased out of the regular financial information kept for bookkeeping purposes. Especially when the numbers have been linked to the main components and drivers of your business. Tracking sales (let’s say revenue) by customer allows you to know the buying trends of your client base. Tracking expenses by products and services allows you to know which ones are costing you the most. Assuming that price points (that drive revenue) and cost points (that drive expense) are linked to customers as well as products & services, these connections allow you to know, and manage, several critical items:
● who your best customers are in terms of sales and revenue
● which products and services are largest in sales and revenue
● which customers provide the highest amount of profit for your company
● which products & services generate the most profit; and which ones are useful loss leaders for attracting other, more profitable, business
If risks are ubiquitous & unavoidable, isn’t the situation hopeless?
No more than life is. To exist is to be exposed to countless risks. Those who survive have learned to handle the risks and threats they face. Those who thrive have learned to manage risks so that adverse impacts are minimized and potential benefits are maximized.
Every risk avoided is a benefit. Every risk your competitors don’t avoid is a benefit. The key challenge is knowing, ahead of time, what risks face your organization and the business(es)/market(s) it is in; understanding how those risks work; and implementing controls to minimize potential bad effects.
For example, viruses are everywhere, ranging from being petty nuisances to causing horrific deaths. Not everybody catches a virus. And for those who do, some are much more debilitated than others. There is a big difference between the common cold and ebola viruses. Even given its awesome devastation, not everybody who is infected with ebola dies.
Risks are exactly the same. The defense is: awareness, understanding, tracking, control and containment.
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