At the core of financial risk management lies the securement of one’s financial basis. This will make a business more resilient to market fluctuations and allow you to experience a higher level of control. Naturally, you want to give your organisation the best conditions to mitigate the consequences of an unpredictable market, which is why working proactively is the way to go!
So, what steps can you take to successfully improve your financial risk management and stay ahead of the game? We have gathered 4 tips for you to consider:
1. Start by analysing the costs
In order for your financial risk management to be efficient, you need to start by figuring out what the direct effects that the financial risks might have are – and how those effects would affect the company. To map out which risks to avoid, we'll use insights from this analysis.
Once we’ve done that, we need to clarify the cost effects and which consequences higher interest rate costs may bring. This is when interest rate forecasts come into play. These types of forecasts with alternative outcomes are known as stress tests. They let us test how sensitive the prognosis is and what risks may arise related to the predicted interest rate costs.
2. Analyse your key figures
How can one quantify the risk of not being able to borrow money? We need to start by defining a specific situation and what preventions you can take to reduce the effects that that specific situation would have.
The primary way to manage the risk of securing funding is to ensure that your company’s existing and potential new loans’ debt maturity dates are distributed over time. That way, you can ensure you don’t have to refinance all of the loans at the same time, thereby minimising the risks that would entail. You can also lean against credit facilities to reduce the funding risk. The bank then agrees to sign a credit facility for the debt that will need to be refinanced over the next few years or any new loans necessary for upcoming projects and acquisitions. This will act as a lifeline, ensuring that your funding is secured for a specific period of time.
These risks should then be illustrated by key numbers that show how much of the debt has a maturity date in the next twelve months in combination with the average capital duration – both with and without regard to the credit facility.
3. Make sure you have a thorough financial strategy
Once you have an analysis of the risks you need to turn it into a clear strategy. Make sure that there’s a plan in place with clear and defined mandates.
Keep in mind that the interest rate risk should be limited based on the business’ capacity to manage the potentially increased costs. You also need to ensure that the strategy has clear guidelines regarding how much of your interest rate is allowed to be variable – and how to manage the parts of the debt with fixed interest rates: recommended average maturity intervals and which tools to use, etc. The strategy should also include how to control the funding risk with the help of the key numbers we mentioned earlier, as well as financing sources and other security measures.
4. Evaluate and revise
It's crucial to evaluate your risk management guidelines regularly. If these past months of record-fast changes in the market situation have proven anything, it's exactly this.
The previously profitable variable interest rate part of the debt portfolio has suddenly become expensive – and its effects on the costs are hard to prevent in the short run, no matter what measures you take. At the same time, the amount of available funding is decreasing, the prices are rising, and credit assessments are becoming more challenging.
Good and well-balanced risk management is about defining and analysing specific risk scenarios to mitigate the effects in time. That’s why it’s essential to evaluate and revise the mandates in your financial strategy if the business or the market situation changes.