As companies throughout the world use capital to drive growth by means of expanding existing enterprises, starting new firms, purchasing existing businesses, or joint venturing with an organization owned by someone else who has skills necessary to compete in the marketplace, they are relying on management to assess risk in order to move an organization forward. Risk is the potential of losing something of value. Value may be gained or lost when taking risk resulting from a given action, activity or inaction. Risk is everywhere, constant, and should be respected instead of feared. Identifying risk is a practice that tempers ambition through a list of “what-ifs,” scrutinizing whether a company has the financial, human and technological resources necessary to reach its goals. Highlighting risks will allow a team to find ways to mitigate risk and increase the probability of success by dealing with issues before they become a problem.
ABC company is considering the purchase of another firm that will increase gross revenue, expand services to customers, and likely to increase net profit. The acquiring firm’s management develops a list of risk points which are things that could go wrong if un-mitigated. Finding ways to mitigate risk will help the acquiring company understand if they have the capability to absorb another firm.
Risk: In order to attract financing the purchase will require a 20% minimum owner contribution having the effect of decreasing liquidity and increasing long term liabilities on the balance sheet. Insufficient liquidity resulting from cash depletion and ongoing principal and interest payments associated with the new debt may cause the operating company to become insolvent which could result in business failure.
Mitigation: The operating company has planned for growth by retaining earnings within the operating company so that they can afford to pay up to 50% of a business purchase. If the company uses their savings to make a 30% down payment and finance the remaining 70% of the purchase price, the debt service coverage ratio based on historical income is 1.50x. Based on this information the operating company has the financial capacity purchasing an existing business.
Risk: The Company being acquired drives revenue through service activities which requires employees to have specific skills to complete revenue producing jobs. Failure to provide service at equal or greater than previous levels may result in loss of revenue and decrease profitability.
Mitigation: Staff will be retained at both companies. Both the operating company and the acquisition serve the same sector but occupy different stages of the supply chain. If anyone from either company left, the total workforce is likely to be able to absorb the workload and continue operations. The acquisition results in greater workforce stability due to a larger labor force with a wider range of skills than compared to before the acquisition.
Risk: The two operating companies have different financial systems. Using two systems requires an extra step to consolidate financial information and may increase the labor required to derive quality feedback from historical operating activities. Slow or inaccurate information is likely to inhibit management’s ability to make informed decisions about how to operate the company which may result in underperformance and decrease profitability.
Mitigation: In the short term it is possible to operate two separate systems but as an order of priority after acquisition, an action plan will be implemented to absorb one company’s system so that only one operating system remains.
The risks highlighted above are internal to the organization. External risks may be related to interest rates, commodity pricing, economic cycles, legislation, regulatory bodies, and the actions of competitors that may impact the company. Remember, the purpose of highlighting risk points is to identify the things that may negatively affect operations so that management is able to anticipate issues and deal with them before they evolve into problems. There will be a time when the correct answer is ‘No, we can’t do that right now,’ which is a natural outcome to a successful planning organization.