Starting a business is no easy task. And growing it and making it sustainable is twice the difficulty of starting it. In an interdependent, global environment, there are so many threats to the success of mSMEs. The US financial catastrophe has led to the fold up of established and respected financial institutions, the impact of which will inevitably be felt by small businesses in our region.

Among our mSMEs, only those who are able to identify and address these threats will be able to sustain themselves and survive. Ideally, it would have been better for them if they were able to identify the risk early on and prepare for such a contingency. This is where risk management comes into the picture. An entrepreneur who knows how to manage risks will likely survive economic reversals.

At the Small Business Corporation we recognize the value of risk management and believe that like the entrepreneurs it serves, SBC as a financial institution and being entrepreneurial itself, must manage the risks relating to its financing operations. Accordingly, SBC recognizes that mSME lending is inherently risky and that it should be able to manage the risks associated with mSMEs for it to be successful in its development efforts.

SBC has identified the factors of risk which can spell the difference between a successful and a failed mSME. Today all its borrowers, especially under the retail lending program, are risk rated. So every borrower is evaluated and given a risk rating which shows the level of credit risk entailed in lending to said borrower.

So what makes an enterprise risky? Following are the factors or situations that are imputed in the credit risk score of borrowers.

Low liquidity and negative cash flows. The enterprise must generate enough cash flow from operation to service current indebtedness. When the cash flow is negative, the ability to repay loans will suffer.

Inefficiency in operations. This is evidenced by poor activity ratios affecting accounts receivables, accounts payables and inventory. Any of these balance sheet items going beyond the average 180 days aging, discounting any possibility of being caused by natural market movement of the product or service, extraordinary events or natural calamities, means inefficient operations. This may not be sustainable in the long run.

High leverage. Debt financing should be leveraged carefully with the revenues being generated by the enterprise. It is alright for the business to finance part of its growth through debt, when basic earning power is greater than cost of debt. However, too high a debt level presents threats of insolvency. A healthy and balanced capital structure must be the aim.

Inexperience of owners and management. An entrepreneur who lacks experience will always encounter more setbacks and challenges than one who has been through it all before and would know how to handle different situations in running the business.

Deteriorating health and lack of succession. Entrepreneurs who are sickly and are hampered by health issues will tend to perform poorly in business. A business whose owner is advanced in age and does not have a designated successor will most likely perish with the entrepreneur.

Poor financial capacity of owners. When the owners do not have any personal assets or have zero net worth (outside of business assets), then it would be difficult for them to inject money into the business should they fall into hard times or crisis situation. This makes the business unsustainable in times of crises. Some margin of safety is a necessity.

Bad attitude to banks. Some borrowers have a history of bad habits. These adverse records show that the entrepreneur has the tendency to violate the rules of the banks. At worst, the bad attitude is a reflection of bad character which may affect negatively the other aspects of running the enterprise. Willingness to pay is just as important as capacity to pay.

Dependency on a few suppliers. A failure in the supplier will also affect production of the enterprise. A simple scenario wherein when there are no supplies means no production thereby impairing the business operations.

Decreasing Sales. A trend of decreasing sales for the past three years does not augur well for the enterprise. The industry where the enterprise belongs would most likely be on the decline. In such a case, it would be better for the entrepreneur to consider a divestment strategy.

Dependency on a few clients. When your business is dependent on just one or two customers, any reversals encountered by your clients will become like a contagious disease and adversely affect your business.

Low production capacity. If the enterprise has limited capacity to produce its product or service, it cannot meet any increased demands for its product or service. Its potential for growth is limited and therefore hinders the development of the business. Capacity encompass both quality and quantity.

Incorrect location. Location in this instance refers to proximity and accessibility to its market and suppliers. A business far from its market and suppliers and business infrastructures will incur additional transport costs. It will find itself hampered in its marketing, collection, and delivery efforts.

Presence of any of the foregoing conditions does not mean the business cannot prosper and be financed. The important thing is that we know the areas of risk and are able to impose safeguards to lessen the risk of default. For the entrepreneur, knowing these risk factors helps in identifying areas for improvement of the enterprise, and hopefully increases the potential for its growth and development.

Author: Mr. Benel P. Lagua is the President / COO of the Small Business Corporation. He is likewise an active member of FINEX. Feedback and comments are welcome at benellagua@alumni.ksg.harvard.edu