Risk minimization strategies for businesses

This essay is an attempt to provide a mental framework for visualizing some of the common strategies used by businesses to minimize risk.  The framework assumes a basic knowledge of Kiyosaki's model.

Robert Kiyosaki is the author of the book Rich Dad Poor Dad.  One of the ideas that he introduces is a simple chart that graphically combines an income statement (the top two boxes) and a balance sheet (the bottom two boxes).  Definitions are deceptively simple.  An asset is anything that puts money into your pocket.  A liability is anything that takes money out of your pocket.

Some things, like a house, can be either an asset or a liability.  A big, fancy house is an asset if you can rent it out for more than your interest, taxes, maintenance and "real" depreciation.  A big, fancy house is a liability if you live in it, do not collect rent and must pay for the interest, taxes, maintenance and "real" depreciation out-of-pocket.

The key to wealth, according to Mr Kiyosaki, is to envision this stack of boxes teetering atop a mountain top.  Diverting income to "Assets" will result in a virtuous cycle that will tip the stack in the direction of wealth creation.    Diverting income to "Liabilities" (i.e., expensive toys) will tip the stack in the direction of wealth destruction.  The choice is yours.

Risk minimization via "containment" or siloing

One way to manage risk is to contain or compartmentalize it.  That entails building firewalls to separate components of your financial life.

Perhaps the first firewall is to split your business from your personal life.  This is a task that benefits from good legal help and good accounting help.  The expectation is that the business will toss money over the fence to your personal life after it becomes successful.

Decoupling Income from Assets

The second firewall is within the business.  It is a firewall between your income statement and your balance sheet.  Countless businesses fail because the owners subsidize the business by strip-mining assets.  An example would be a young couple who inherited $200,000, opened a pizza place and were surprised when they bounced a check two years later.  The entire $200K is gone and the bounced check was the first indication that their business is not viable.

This firewall is one that any decent accountant can help you set up.  While it may seem restrictive, it forces the business owner to be more responsive to subtle shifts in the market because they can not smooth the bumps away by unknowingly burning assets.

Insuring assets

Insuring assets is a way of protecting assets from the fickle-finger-of-fate and from every opportunistic predator who would steal your wealth.

In some cases, your insurance company will help (sometimes mandate) how you do business to minimize their risk.  One example might be that the insurance carrier require that equipment operators be licensed drivers.  Another example might be that you not solicit high risk business like roofing and only do it as an incidental part of a larger jobs.

An important asset to consider insuring is the owner's life.  In most cases, the owner IS the business.

The euphemism for dying "He bought the farm" comes from the fact that a family would buy mortgage insurance contingent on the farmer's life.  In the event that he died before the mortgage was paid off, the policy would pay the remainder of the mortgage to ensure the continuance of the business and the well-being of the family.

Virtually any insurance agent with a pulse can sell you life insurance.  The insurance agents who can sell you functional, meaningful business insurance is much smaller.  The key to keeping this insurance affordable is to run a tight ship with regard to assets.  The more assets you require to run your business the more it will cost to insure them.

The second key to keeping business insurance affordable is to avoid claims.  Take care of the things you can take care of.  Address issues, hazards, before they become a customer-driven claim.

Loans

One of life's supreme ironies is that the only people who can borrow money are the people who do not need it.

But flip the observation on its head.  If you can configure your business to be acceptable to bankers then you have de facto evidence that you armored your business to an exceptional degree.

The series of firewalls described in this essay goes a long way toward making the business case you lay on the banker's desk.  This might be the final decoupling:  using other people's assets to run your business.

There are downsides to leveraging.  Highly leveraged businesses are rockets up.  And they are rockets down.  They increase your business's sensitivity to every hiccup in the economy.

Still, it is good to know that you can borrow money if an extraordinary opportunity comes up.