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Credit risk: a few easy steps can prevent major headaches, even extinction

Entrepreneurs are constantly setting up companies as new business opportunities arise. It’s called innovation, and that’s what Silicon Valley is all about. VCs put their money into these companies to help them grow with the expectation that they will make a great return on investment themselves—and they perform significant due diligence and risk assessment before investing.

So it always surprises me when many of these innovative companies that have been assessed for investment risk by their backers act cavalier when it comes to managing the financial risks within their fledgling businesses. Even more surprising is that many of the venture funds that have invested their money never question the company’s approach to financial risk management.

Many companies, particularly start-ups, sell on terms without checking out their customers for credit risk or taking steps to reduce risk. They are so intent on making the sale to show they have a real business (maybe even desperate) that the quality of the sale doesn’t matter. Many have been burnt when they don’t get paid, and others have gone out of business.

Make sure a customer’s credit is good

All of this is avoidable with a few basic steps—and the most basic of all is to check the credit worthiness of a new customer. It takes a minimal amount of time to do, yet in many cases it’s seen as an unnecessary hassle. (This is rarely a problem in public companies, as a basic SOX control on revenue recognition is a requirement to assess collectability. That is one area where SOX has added a lot of value.)

If it is not possible to establish a customer’s credit competence, get them to prepay, use a credit card or provide some sort of guaranteed financial instrument. I have rarely seen a sale cancelled because appropriate terms cannot be agreed upon, yet I have seen companies suffer a lot of pain when they realize, too late, that they have made a poor sale. It’s not only the loss of the receivable that hurts. The cost in time, effort and third-party services to chase the money can be exorbitant, too.

Make sure that credit stays good—and take basic precautions

In addition, companies need to reassess credit terms on a regular basis. Often I see companies check out credit risk and give terms for an initial sale, but they never reassess the customer’s credit risk thereafter, not even when the customer deviates from the agreed terms on that sale or a subsequent sale. Sooner or later that approach comes back to haunt them.

The same is true of credit concentration. Having most of your eggs in one basket is not a good idea, yet many companies do it. Whenever possible, take basic precautions to limit credit concentration, such as selling through multiple channels, or enforcing and continually reassessing credit limits on larger accounts.

Companies that sell overseas also take on significant risk with currency exposure when they sell on inappropriate terms or when the currency risk is not hedged properly. Given the constant headlines about the euro crisis and the considerable downside risk with little upside potential, why do so few companies spend no time considering and minimizing their risk? Beats me.

What I do know is that a small amount of time invested in managing credit and currency risk can save a lot of headaches down the road. It could mean the difference between being in business and becoming extinct.

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New report: The dynamic company’s guide to thriving in Silicon Valley

RoseRyan’s nearly 20 years of helping Silicon Valley companies have shown us a thing or two about what it takes to make it here. We didn’t want to keep all that insight to ourselves, so we’ve compiled some of our best observations and advice in our new report, Strategic Finance in Action: How Dynamic Silicon Valley Companies Seize Opportunities (and Avoid Flameouts).

Our report recounts responses to real-life challenges that show how strategic finance thinking in action can make the difference between struggling and thriving. The upshot: a business-savvy finance team that can see beyond the numbers and outside the cubicle is a fast-moving company’s BFF.

Some of the scenarios we get inside include:

A life sciences company with a promising drug nearing payoff (they think) is contending with a business IT system that makes day-to-day operations a frustrating slogfest. What’s the next move?

A hot social media start-up is taking off, but their young staff lacks the chops to keep pace—and they’ve sprung a cash leak. Can they plug it? Could they have prevented it?

A tech company with game-changing technology needs to scale fast to meet demand, but the capital well is drying up and a decent revenue stream is only a gleam in the CEO’s eye. How to stay afloat without missing the market?

Can you relate? Check out our report to see what happened. And you’ll learn about other strategic finance solutions in capital efficiency, business information systems, process optimization, and people and culture. We hope you enjoy it.

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Don’t let the cloud rain on your parade

I hear a lot about the many virtues of moving to the cloud. There are a lot of reasons this makes sense—among other things, the cloud can provide greater efficiencies, reduce costs, enhance productivity, remove geographic barriers and improve disaster recovery. And with so many cloud-based applications available and more hitting the market constantly, it definitely is the way of the future (if not the present).

But the articles I’ve read tend to focus on the benefits, and working in the cloud is not without risks. You don’t control the platform, and your company’s critical data (about employees, finances, customers, etc.) is being stored outside your premises with a third party. Even though someone else is managing your data, you are still responsible for what happens to it. Here are a few risks to consider:

Data location. Where is your data being hosted? Data protection and privacy regulations in many countries specify where certain employee data can be physically located. Also, different countries provide different legal protections, so if your provider moves its data center to another country there could be serious consequences for you.

Data ownership and migration. What happens to your data if you switch vendors or if a vendor goes out of business? Will it disappear? Will it be deleted securely? Will it cost to transfer your data from the vendor at the end of the contract?

Security. What controls are in place for transmitting data to your cloud provider and storing data securely? Is customer access secure? How are security breaches handled, and how soon are customers notified? (Ask for a SOC2 report to help assess data protection and security.)

Reliability. Industry standard uptime is greater than 99 percent. Does your provider meet that? How often is maintenance performed? How are customers notified of scheduled down time? What is the disaster recovery plan? Are full backups taken at least daily? Are there redundant sites and systems?

Integration. Evaluate how well the application integrates with existing applications (both in the cloud and at your location).

If you’re moving to the cloud, be smart—weigh costs and benefits, and evaluate options carefully. If you have an enterprise risk management (ERM) program in place, make sure the cloud is part of your strategy. Know what your risks are and address them up front; if something goes wrong you may be looking at business disruptions, damage to your reputation, lost customers and more. You don’t want to be surprised.

Don’t have an ERM program? Learn more about ERM for midsize companies in our latest report, ERM: Not Just for the Big Guys.

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