Risk Metrics will be viewed by risk managers (where the company has a separate risk function) or by its Board or senior management team (functional directors) in a smaller business. They will also be of importance to external stakeholders such as investors and lenders/creditors. The company should track areas of risk and uncertainty which hold the greatest potential danger for the business if external shocks or changes were to cause sales to decrease or other deterioration of the company’s results. Cash flow is considered the primary risk metric as it gives a clear indication of both the health and sustainability of the business.
Typical risk metrics may include:
1. Net cash flow in a given period and over the last few periods or years. This is particularly important if negative (cash outflow).
2. How many months or years can the company sustain itself at the present levels and cash flows, if sales were to remain level (also known as burn rate). How would this be impacted if sales were to decrease by (say) 5%, 10%, etc.
3. What is happening to the customer base over time, in terms of total customer numbers (existing customers – customers lost in period + new customers acquired in period) – is this increasing, decreasing or remaining level.
4. The churn rate or attrition rate, i.e. the rate at which newly acquired customers drop off within one year of acquisition, which gives an indication of the long-term sustainability of the business in its present form.
5. The proportion of revenues which come from newly acquired customers vs. long-term existing customers, and how well the company is converting new customers into long-term existing customers who buy again and again. Where significant levels of revenues are generated from new customers, which requires a constant pipeline of new customers (yet drawing from a dwindling overall marketplace of potential prospects), the more risk there will be for the business in the long-term. Conversely, where the business generates a greater proportion of sales from long-term existing customers, the lower the risk to the company.
6. Customer bad debt levels and credit default risk, which can vary dependent on the industry or product, customer type, customer credit levels currently being offered or how well (or badly) the company chases for and collects defaulted customer debts.
7. Risks associated with the company’s debt levels (such as loans or overdraft) can be affected by changes in sales levels, where interest and capital payments need to be continued despite dwindling cash receipts (allied to 1. and 2. above). Metrics here would be both the overall total debt carried, as well as the monthly and annual debt/interest repayments due.