How MSMEs can undertake risk management in business

Ease of doing business for MSMEs: 10,655—that’s the number of Micro, Small, and Medium Enterprises (MSMEs) that have shut down in the last 10 months (April to February 2023) alone. This is also the highest number of MSME closures in the last 3 years! Granted that the Covid-19 pandemic wrecked the business landscape, but the government has made multiple efforts to keep India’s small and medium businesses going. So, why are MSMEs flailing? For starters, though MSMEs are subject to the same kind of risks as large companies, most of them do not have the financial means required to mitigate and manage these risks. This makes staying afloat a big challenge in a harsh business environment. This also makes MSMEs risk-averse because a single mistake can cause the business to fail.

MSME risks can be classified into two types: internal risks and external risks. Internal risks include all risks that can be controlled by the business and its owners, e.g., internal fraud, compliance risk, over-leverage, concentration risk, etc. External risks are the risks that are beyond the control of the business, e.g., black swan events, rising inflation and interest rates, changes in laws, natural disasters, etc.

MSMEs can survive and grow only if they have adequate risk management plans to identify, assess, monitor, manage, mitigate and control these risks. These risk management plans should focus on the following:

  1. Aim to make the company agile: “What can we quickly scale up in case of an opportunity? What can we rapidly scale down if there is a slowdown, thus conserving cash? Which are the areas in which we need to be more agile?”, are questions that MSMEs need to ask themselves while developing their risk management policy.
  2. Take informed risk decisions: Making risk decisions based on independent and verified data is now easier than ever before. Taking a blind leap of faith and making uninformed decisions is a strict no-no in today’s volatile environment. Plenty of risk management tools and platforms are available to help MSMEs make informed decisions.
  3. Focus on human capital: Employee attrition is a big risk for MSMEs, as is internal fraud committed by employees. Both are linked to employee satisfaction with working conditions and compensation. When employees are unhappy, they leave, which means losing trained resources and incurring additional costs in recruiting and training their replacements. For a small business, these costs can be significant. Ensuring that employees are paid and treated fairly and made to feel a part of the company’s growth story will help address employee attrition and also reduce the motivation to commit fraud. There also needs to be an effective whistle-blower mechanism to ensure timely reporting of fraudulent activities without the fear of repercussions.
  4. Scenario Analysis for better Risk Management: For a risk management plan to be successful, there needs to be a thorough understanding of all aspects of the business and how one risk is interconnected with another. For eg., spiralling cost of raw materials, forex rate changes, escalating freight costs etc, can destroy a business – very often, they occur simultaneously. MSMEs need to conduct detailed scenario analyses for different risks and develop plans to mitigate them.
  5. Build a network of peers: Experience is the best teacher and MSMEs can learn from the experiences of others. Being a part of an association or peer group of small business owners helps MSMEs learn from the failures of others and they can avoid making similar mistakes.
  6. Build an emergency nest egg or keep a credit line on standby: For an MSME, having that little bit of financial buffer to tide over a really difficult time can make the difference between survival and death. The Indian Government’s Emergency Credit Line Guarantee Scheme (ECLGS), introduced during the COVID-19 period has benefitted nearly 1.2 crore MSMEs. Creating a contingency fund is really important for MSMEs as they are vulnerable to sudden changes in business conditions.
  7. Monitor cash flow carefully and optimise working capital: MSMEs need to implement solutions and processes that can shorten their Days Sales Outstanding (DSO) and ensure that their cash flow is positive, thus reducing excessive reliance on external funding. MSMEs can also leverage the TReDS platforms to quickly generate cash against their supplies to corporate entities.

There are several risk management platforms that MSMEs can use to manage their risk better. Let us look at some potential scenarios in which these platforms are very useful:

Use Case 1: Credit Risk Management

Problem Statement: An MSME has a limited ability to provide credit and cannot afford bad debts. How does it decide to whom should the credit be given?

Solution: The MSME can deploy a plug-and-play automated third-party credit risk management platform that will evaluate and score the counterparty credit risk for each customer, distributor, or dealer. The platform also recommends credit limits for them depending on their risk scores. By using such platforms, MSMEs can allot credit limits optimally to their customers and ensure that bad debts are avoided and cash flow is effectively managed.

Use Case 2: New Customer Onboarding

Problem Statement: An MSME is usually in a hurry to drive new sales and very often does not bother checking the antecedents of its prospective customers. How can it avoid onboarding dodgy customers who can defraud it?

Solution: The MSME can use a third-party KYC validation platform to quickly conduct KYC checks of prospective customers before onboarding them. Such platforms deploy efficient and inexpensive Video KYC and e-KYC Solutions which help validate the identity of prospective customers by checking statutory databases via API. These platforms also help reduce onboarding time by 75 per cent making the customer’s experience very smooth and seamless.

Use Case 3: Supplier Risk Monitoring

Problem Statement: MSMEs work with several suppliers, some of which are mission-critical. So, how does an MSME monitor the risk of its suppliers to anticipate any potential disruption in supply?

Solution: Disruptions at the supplier’s end can prevent the flow of materials to the MSME, resulting in costly production delays and cash flow problems. The MSME can deploy a plug-and-play Early Warning System (EWS) to detect changes in the risk profile of its suppliers by monitoring parameters such as statutory compliances, rating downgrades, bankruptcy alerts, new litigation etc. MSMEs can, thus, identify suppliers whose risk profile is deteriorating and work on developing alternate suppliers to preempt supply disruptions.

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