Welcome to the 255, where we help business owners like you unlock the full potential of your business through practical strategies and clear guidance. I'm Arnold Shields and I'll be your host as we explore a powerful framework that helps you make smarter decisions and maximise profitability and build long term value.
In this podcast series, we'll be breaking down a framework I call The 255, which stands for two fundamentals, five multipliers and five foundation stones that form the basis of a thriving business.
Whether you're just starting out or managing an established company, this framework is practical and actionable. It's designed to help you make smarter decisions and achieve greater profitability step by step.
In the last episode, I spoke about the first fundamental - cashflow. Today I am going to talk about its buddy, the second fundamental - Risk
In the past episodes, I spoke about the 2 core roles of the CEO. One to develop a vision from the business and the path to get there and two keeping the business on that path.
In order to stay on that path the CEO needs to ensure that the business has sufficient resources to be able to achieve it’s goal which is cashflow.
The other aspect of keeping the business on track is responding to things that work to keep the business from its path. The things that go wrong or risk.
That is what we are going to talk about today risk. The buddy of cashflow is risk, when you think about what the cashflows of the business both future and current we need to think about what can go wrong with those cashflows which is risk
The two fundamentals of the 255 framework are cashflow and risk.
Both cashflow and risk are ignored or paid scant attention by business owners. They think about their current cashflow and what is going wrong currently but they don't look forward at what their cashflows and risks are going to be in the future.
The role of the CEO is to look into the future about how they what their business to be - the vision - they also have to project the path that their business is taking now and is that going to deliver them to their vision. Are we flying in the right direction - are we going to end up in New York or Miami or Buenos Aires?
Risks can derail the direction of the business.
What is risk?
It’s a probability of threat or damage, injury, liability loss or any other negative occurrence that has occurred through external and internal vulnerabilities that may be avoided through preemptive action.
There's two parts to that definition:
Something negative caused by external or internal vulnerabilities;
and that could be avoided through preemptive action.
Risk basically equals loss due to something that can be avoided.
Uncertainties in a business context refer to unpredictable elements that can affect the organization's ability to achieve its objectives. Unlike risks, which can be identified and quantified to some extent, uncertainties are often unknown and cannot be easily measured or predicted. They arise from various sources and can have significant impacts on strategic planning, decision-making, and overall business performance.
Risk in a business context refers to the possibility that an event or action will negatively affect the organization's ability to achieve its objectives. This can involve potential losses, adverse effects on operations, financial instability, or damage to the company's reputation. Understanding and managing risk is crucial for businesses to ensure long-term success and stability.
Risk is something that can be avoided or managed.
Managing risk means taking proactive decisions about how your business be affected by negative outcomes.
Risk are things that you need to work on in your business. As your business grows, it's going to develop more vulnerabilities, and your job as a CEO of the businesses, as the owner or the managing director, is to plug those holes in your business to reduce the risk.
The process of mitigating risk involves first identifying the potential risks, then assessing the potential risk, developing strategies to reduce or manage risks and then continuously monitoring risks and the effectiveness of mitigation strategies.
Depending on the size of your business the response to risk will be different. In small businesses, there may be inherent risk in your business that you may have to accept but there is always easy that you can mitigate the risk.
For example, you are selling a single product on Amazon.com. You have a number of concentration risks.
Product risk - you rely upon one product that product could be subject to competition,
Customer risk - you effectively have one customer Amazon who could close you down at any time,
Leads Risk - you are dependent upon your organic ranking on Amazon.
The cashflow of your business is dependent on stability in each of these areas - failure in any one of these could be the failure of your cashflow. You might not be able to do anything for the moment about selling on the Amazon platform at the moment as it would be too expensive and time consuming to develop our own profitable shopify site but there is other things to do to mitigate and minimise the risk.
Launch more products so that you are not dependent upon one product.
Ensure that you are complying with Amazon’s terms and conditions so that you minimise the risk of being suspended or blocked by Amazon.
If you are heavily dependent upon organic rank, developing your PPC and depth of your keyword rankings so that if you lose rank for the main keyword you have other sources of leads.
Minimise the risk to your cashflow - ensure that you do not overcommit on your cashflow agreeing to loan repayments. Building up your cash reserves so that you have the ability to recover if something bad happens.
We see many surprised when something negative happens blaming everyone but themselves, when the risks were always there and they failed to identify them, assess their impact or mitigate the risk.
The role of the CEO is to keep the business on track towards the vision. Risk will try and derail you, as the CEO you need to be manage these risks.
So let's look at the types of risk:
First up, Concentration risk is the potential for a business to suffer significant financial loss due to an over-reliance on a limited number of sources.
Product Concentration Risk - overreliance of a single or group of products or services for a large portion of your income. You have the hero product - it is profitable and sells well but it is a risk if competition or market conditions changes.
Customer Concentration Risk - dependent on one customer or segment of customers for a majority of your income. You have that one big client that is responsible for a large portion of your income.
Market Concentration Risk - you focus on one market or geographical segment. For example you sell on Amazon USA only or you service one particular segment in a market.
Supplier Concentration Risk - you have one supplier. If something happens to that supplier it has delays, then your business is at risk.
People Concentration Risk - you are dependent on a single person for areas of expertise within your business.
Leads Concentration Risk - your leads come from one source. All your leads from organic rankings on Amazon or Google. Many businesses went under when Google changed it’s search algorithm. You might be dependent on a single referral source - a bank manager, a real estate agent, a contact in an upstream or downstream business.
Investment Concentration Risk; you are overreliant on one sector within your investment portfolio like banks, mining, technology etc.
The primary way to mitigate against concentration risk is diversification:
Adding more products, brands and services to your offering
Finding new customers, selling on different platforms Shopify, Walmart etc.
Opening up new markets - UK, Europe even different states.
Finding backup suppliers
Reducing people risk through systems.
You can also reduce concentration risk, by changing your operations so that if something bad happens the risk of threatening your cashflow is reduced. In our Amazon business, we now hold lower inventory in Amazon, through smaller more frequent shipments into Amazon.
The risk of relying upon Amazon is not only the potential cashflow loss from sales falling but also the loss of inventory potentially tied up in Amazon. We can mitigate the risk by holding less inventory in Amazon through improving our supply chain logistics.
Lets quickly go over the other Types of Business Risk
Financial Risk
Credit Risk: The possibility that customers or borrowers will not repay their debts.
Liquidity Risk: The risk that a business will not be able to meet its short-term financial obligations due to insufficient cash flow.
Market Risk: The risk of losses due to changes in market conditions, such as fluctuations in stock prices, interest rates, or currency exchange rates.
Operational Risk
Process Risk: The risk of failures in business processes, which can lead to disruptions and inefficiencies.
People Risk: Risks associated with human resources, including talent management, employee errors, or misconduct.
System Risk: Risks related to information technology systems, including cyberattacks, data breaches, and system failures.
Strategic Risk
Competitor Risk: The risk of losing market share to competitors due to strategic decisions.
Innovation Risk: The risk associated with failing to innovate or adapt to industry changes, potentially leading to obsolescence.
Reputation Risk: The risk of damage to the company's reputation due to negative publicity, poor customer service, or ethical breaches.
Compliance and Legal Risk
Regulatory Risk: The risk of non-compliance with laws and regulations, which can result in fines, legal penalties, and reputational damage.
Litigation Risk: The risk of legal actions taken against the company, leading to financial losses and reputational harm.
External Risk
Economic Risk: The risk of adverse economic conditions, such as recessions or inflation, affecting the business's performance.
Environmental Risk: Risks related to environmental factors, such as natural disasters, climate change, and environmental regulations.
Political Risk: The risk of political instability, changes in government policies, or geopolitical tensions impacting business operations.
Risk is relative to other risks. We need to concentrate on what is important. Large multinationals have the resources and need to mitigate almost all levels of risk within a business.
As a small business, you will have to pick your fights and look at the risk quadrant. Picture a simple graph - on one axis - the potential impact and the other the probability. Risk may have a high impact and a high probability - those we have to do something about. Other risks may have a low impact and low probability, we could ignore those.
Another way to think about risk is volatility - the effect of risk is volatility in your sales, profits and cashflows. The volatility represents you moving off the path to your vision.
Volatility also brings us to the Valuation of businesses.
The valuation formula is essentially Cashflow x Risk. If we look at a simple Business Valuation Formula which is Profits times Capitalisation Multiple - The Capitalisation Multiple is Risk relative to other investments. A more complicated business valuation formula is Discounted Cashflow which is the future expected cashflows discounted for risk.
The difference between the capitalisation multiples of government bond, public company and a private company is risk. Risk that the return on investment will be different than expected.
Public companies and large multinationals will differ in their capitalisation multiples because of the volatility of their earnings. Those that are less risky, less volatile in their earnings will be worth more.
So we start to come back to why the two fundamentals of business are cashflow and risk and why they are the core responsibility of the CEO. The value of the business is a function of cashflow and risk. The CEO wants to maximise the value to the shareholders as their core responsibilities are cashflow and risk.
So let's look at risk a bit more.
One of the most simple ways to mitigate risk is the application of Test Measure Scale in respect of any decision. You are about to try a new influencer program on Instagram, there are celebrities with millions of followers and the cost of a single promotion is $150,000 up front. Other brands have made millions in sales from just one promotion.
But there are so many things that could go wrong - the image might be wrong, the offer not appealing enough to get a click, the landing page unconvincing, the checkout might not work or have too many steps. So how do we fix it.
Test Measure Scale. We run a series of different images offers etc with smaller influencers at minimal cost. We measure which images and offers work and find the best combinations and then Scale by using the winning combination with the celebrity.
Test Measure Scale should be used in everything. New products - order a small minimum quantity even if is more expensive, test whether the product can sell and make whatever changes are necessary to get it to sell efficiently. Your conversion rate will be the measure. If it works then start ramping up production. If it doesnt, you have not lost much. You don’t want to be sitting on 5,000 units of a product that you cannot sell, when you could have tested it with 200 units.
I wanted to also cover the issue of leverage and compounding risk. Basically you can use borrowings (loans) to leverage your own capital to get a greater return.
People do this all the time with property. Buy a property for $1 million, use a 10% deposit of $100,000 and borrow $900,000. The property goes up in value to $1.2million and you have made $200,000 of your investment of $100,000, excluding interest.
The leverage enables you to get greater returns from your invested capital. If the value decreases, leverage also increases the loss.
Comparatively real estate is much less risky that shares. Whilst you can leverage real estate at 10%, if you want to do margin lending on the top companies you might only be able to borrow 50% of the value.
Small businesses are more risky and you need to be careful of compounding your risk. You have a hero product on Amazon that is selling well and you keep running out of inventory but your cashflows are not sufficient to buy enough stock.
You have a number of risks - product concentration risks with the hero product, Customer and market and lead concentration risk with selling on Amazon, you have a structural risk in your balance sheet with low cash and inventory.
You decide to borrow to fund more inventory, so you are adding more risk to the business, you are compounding the risk through leverage.
A simple tip, what risks do you concentrate on. Simple - those risks that are prevalent in the multipliers - Leads, Conversion Rate, Average Dollar Sale, Contribution Margin, Valuation Multiplier because that is where the largest impact will be.
The 255 Framework consists of 2 fundamentals, 5 multipliers and 5 foundation stones of which the two fundamentals are cashflow and risk. Today i just introduced these concepts and in future episodes, I will come back to them.
In next weeks episode, we are going to get talk about the business formula and the first multiplier which is Leads.
The key takeaway today is:
Think about the main risks to your business
Map them on a risk quadrant - Impact (High or Low) , Probability (High or Low)
This process will help you focus on what is important and what you need to look at mitigating or minimizing the impact.
Thank you for tuning in to today’s episode of The 255 Framework.
I look forward to diving deeper with you in the next episode as we continue to explore the ins and out of The 255 Framework.
If you enjoyed today’s episode, make sure to subscribe to Spotify, Apple Podcast, Youtube so you don’t miss any upcoming episodes.
And if you have questions or topics you’d like me to cover, reach out to me via LinkedIn - Arnold Shields.
I’d love to hear from you and include your questions in future discussions.
Once again, I’m Arnold Shields, and this is "The 255." Thanks for listening, and I’ll see you next time.
Podcast Episode 3: What is Risk?
Introduction
Welcome to the 255, where we help business owners like you unlock the full potential of your business through practical strategies and clear guidance. I'm Arnold Shields and I'll be your host as we explore a powerful framework that helps you make smarter decisions and maximise profitability and build long term value.
In this podcast series, we'll be breaking down a framework I call The 255, which stands for two fundamentals, five multipliers and five foundation stones that form the basis of a thriving business.
Whether you're just starting out or managing an established company, this framework is practical and actionable. It's designed to help you make smarter decisions and achieve greater profitability step by step.
In the last episode, I spoke about the first fundamental - cashflow. Today I am going to talk about its buddy, the second fundamental - Risk
In the past episodes, I spoke about the 2 core roles of the CEO. One to develop a vision from the business and the path to get there and two keeping the business on that path.
In order to stay on that path the CEO needs to ensure that the business has sufficient resources to be able to achieve it’s goal which is cashflow.
The other aspect of keeping the business on track is responding to things that work to keep the business from its path. The things that go wrong or risk.
That is what we are going to talk about today risk. The buddy of cashflow is risk, when you think about what the cashflows of the business both future and current we need to think about what can go wrong with those cashflows which is risk
The two fundamentals of the 255 framework are cashflow and risk.
Both cashflow and risk are ignored or paid scant attention by business owners. They think about their current cashflow and what is going wrong currently but they don't look forward at what their cashflows and risks are going to be in the future.
The role of the CEO is to look into the future about how they what their business to be - the vision - they also have to project the path that their business is taking now and is that going to deliver them to their vision. Are we flying in the right direction - are we going to end up in New York or Miami or Buenos Aires?
Risks can derail the direction of the business.
What is risk?
It’s a probability of threat or damage, injury, liability loss or any other negative occurrence that has occurred through external and internal vulnerabilities that may be avoided through preemptive action.
There's two parts to that definition:
Something negative caused by external or internal vulnerabilities;
and that could be avoided through preemptive action.
Risk basically equals loss due to something that can be avoided.
Uncertainties in a business context refer to unpredictable elements that can affect the organization's ability to achieve its objectives. Unlike risks, which can be identified and quantified to some extent, uncertainties are often unknown and cannot be easily measured or predicted. They arise from various sources and can have significant impacts on strategic planning, decision-making, and overall business performance.
Risk in a business context refers to the possibility that an event or action will negatively affect the organization's ability to achieve its objectives. This can involve potential losses, adverse effects on operations, financial instability, or damage to the company's reputation. Understanding and managing risk is crucial for businesses to ensure long-term success and stability.
Risk is something that can be avoided or managed.
Managing risk means taking proactive decisions about how your business be affected by negative outcomes.
Risk are things that you need to work on in your business. As your business grows, it's going to develop more vulnerabilities, and your job as a CEO of the businesses, as the owner or the managing director, is to plug those holes in your business to reduce the risk.
The process of mitigating risk involves first identifying the potential risks, then assessing the potential risk, developing strategies to reduce or manage risks and then continuously monitoring risks and the effectiveness of mitigation strategies.
Depending on the size of your business the response to risk will be different. In small businesses, there may be inherent risk in your business that you may have to accept but there is always easy that you can mitigate the risk.
For example, you are selling a single product on Amazon.com. You have a number of concentration risks.
The cashflow of your business is dependent on stability in each of these areas - failure in any one of these could be the failure of your cashflow. You might not be able to do anything for the moment about selling on the Amazon platform at the moment as it would be too expensive and time consuming to develop our own profitable shopify site but there is other things to do to mitigate and minimise the risk.
We see many surprised when something negative happens blaming everyone but themselves, when the risks were always there and they failed to identify them, assess their impact or mitigate the risk.
The role of the CEO is to keep the business on track towards the vision. Risk will try and derail you, as the CEO you need to be manage these risks.
So let's look at the types of risk:
First up, Concentration risk is the potential for a business to suffer significant financial loss due to an over-reliance on a limited number of sources.
Product Concentration Risk - overreliance of a single or group of products or services for a large portion of your income. You have the hero product - it is profitable and sells well but it is a risk if competition or market conditions changes.
Customer Concentration Risk - dependent on one customer or segment of customers for a majority of your income. You have that one big client that is responsible for a large portion of your income.
Market Concentration Risk - you focus on one market or geographical segment. For example you sell on Amazon USA only or you service one particular segment in a market.
Supplier Concentration Risk - you have one supplier. If something happens to that supplier it has delays, then your business is at risk.
People Concentration Risk - you are dependent on a single person for areas of expertise within your business.
Leads Concentration Risk - your leads come from one source. All your leads from organic rankings on Amazon or Google. Many businesses went under when Google changed it’s search algorithm. You might be dependent on a single referral source - a bank manager, a real estate agent, a contact in an upstream or downstream business.
Investment Concentration Risk; you are overreliant on one sector within your investment portfolio like banks, mining, technology etc.
The primary way to mitigate against concentration risk is diversification:
You can also reduce concentration risk, by changing your operations so that if something bad happens the risk of threatening your cashflow is reduced. In our Amazon business, we now hold lower inventory in Amazon, through smaller more frequent shipments into Amazon.
The risk of relying upon Amazon is not only the potential cashflow loss from sales falling but also the loss of inventory potentially tied up in Amazon. We can mitigate the risk by holding less inventory in Amazon through improving our supply chain logistics.
Lets quickly go over the other Types of Business Risk
Financial Risk
Credit Risk: The possibility that customers or borrowers will not repay their debts.
Liquidity Risk: The risk that a business will not be able to meet its short-term financial obligations due to insufficient cash flow.
Market Risk: The risk of losses due to changes in market conditions, such as fluctuations in stock prices, interest rates, or currency exchange rates.
Operational Risk
Process Risk: The risk of failures in business processes, which can lead to disruptions and inefficiencies.
People Risk: Risks associated with human resources, including talent management, employee errors, or misconduct.
System Risk: Risks related to information technology systems, including cyberattacks, data breaches, and system failures.
Strategic Risk
Competitor Risk: The risk of losing market share to competitors due to strategic decisions.
Innovation Risk: The risk associated with failing to innovate or adapt to industry changes, potentially leading to obsolescence.
Reputation Risk: The risk of damage to the company's reputation due to negative publicity, poor customer service, or ethical breaches.
Compliance and Legal Risk
Regulatory Risk: The risk of non-compliance with laws and regulations, which can result in fines, legal penalties, and reputational damage.
Litigation Risk: The risk of legal actions taken against the company, leading to financial losses and reputational harm.
External Risk
Economic Risk: The risk of adverse economic conditions, such as recessions or inflation, affecting the business's performance.
Environmental Risk: Risks related to environmental factors, such as natural disasters, climate change, and environmental regulations.
Political Risk: The risk of political instability, changes in government policies, or geopolitical tensions impacting business operations.
Risk is relative to other risks. We need to concentrate on what is important. Large multinationals have the resources and need to mitigate almost all levels of risk within a business.
As a small business, you will have to pick your fights and look at the risk quadrant. Picture a simple graph - on one axis - the potential impact and the other the probability. Risk may have a high impact and a high probability - those we have to do something about. Other risks may have a low impact and low probability, we could ignore those.
Another way to think about risk is volatility - the effect of risk is volatility in your sales, profits and cashflows. The volatility represents you moving off the path to your vision.
Volatility also brings us to the Valuation of businesses.
The valuation formula is essentially Cashflow x Risk. If we look at a simple Business Valuation Formula which is Profits times Capitalisation Multiple - The Capitalisation Multiple is Risk relative to other investments. A more complicated business valuation formula is Discounted Cashflow which is the future expected cashflows discounted for risk.
The difference between the capitalisation multiples of government bond, public company and a private company is risk. Risk that the return on investment will be different than expected.
Public companies and large multinationals will differ in their capitalisation multiples because of the volatility of their earnings. Those that are less risky, less volatile in their earnings will be worth more.
So we start to come back to why the two fundamentals of business are cashflow and risk and why they are the core responsibility of the CEO. The value of the business is a function of cashflow and risk. The CEO wants to maximise the value to the shareholders as their core responsibilities are cashflow and risk.
So let's look at risk a bit more.
One of the most simple ways to mitigate risk is the application of Test Measure Scale in respect of any decision. You are about to try a new influencer program on Instagram, there are celebrities with millions of followers and the cost of a single promotion is $150,000 up front. Other brands have made millions in sales from just one promotion.
But there are so many things that could go wrong - the image might be wrong, the offer not appealing enough to get a click, the landing page unconvincing, the checkout might not work or have too many steps. So how do we fix it.
Test Measure Scale. We run a series of different images offers etc with smaller influencers at minimal cost. We measure which images and offers work and find the best combinations and then Scale by using the winning combination with the celebrity.
Test Measure Scale should be used in everything. New products - order a small minimum quantity even if is more expensive, test whether the product can sell and make whatever changes are necessary to get it to sell efficiently. Your conversion rate will be the measure. If it works then start ramping up production. If it doesnt, you have not lost much. You don’t want to be sitting on 5,000 units of a product that you cannot sell, when you could have tested it with 200 units.
I wanted to also cover the issue of leverage and compounding risk. Basically you can use borrowings (loans) to leverage your own capital to get a greater return.
People do this all the time with property. Buy a property for $1 million, use a 10% deposit of $100,000 and borrow $900,000. The property goes up in value to $1.2million and you have made $200,000 of your investment of $100,000, excluding interest.
The leverage enables you to get greater returns from your invested capital. If the value decreases, leverage also increases the loss.
Comparatively real estate is much less risky that shares. Whilst you can leverage real estate at 10%, if you want to do margin lending on the top companies you might only be able to borrow 50% of the value.
Small businesses are more risky and you need to be careful of compounding your risk. You have a hero product on Amazon that is selling well and you keep running out of inventory but your cashflows are not sufficient to buy enough stock.
You have a number of risks - product concentration risks with the hero product, Customer and market and lead concentration risk with selling on Amazon, you have a structural risk in your balance sheet with low cash and inventory.
You decide to borrow to fund more inventory, so you are adding more risk to the business, you are compounding the risk through leverage.
A simple tip, what risks do you concentrate on. Simple - those risks that are prevalent in the multipliers - Leads, Conversion Rate, Average Dollar Sale, Contribution Margin, Valuation Multiplier because that is where the largest impact will be.
The 255 Framework consists of 2 fundamentals, 5 multipliers and 5 foundation stones of which the two fundamentals are cashflow and risk. Today i just introduced these concepts and in future episodes, I will come back to them.
In next weeks episode, we are going to get talk about the business formula and the first multiplier which is Leads.
The key takeaway today is:
Thank you for tuning in to today’s episode of The 255 Framework.
I look forward to diving deeper with you in the next episode as we continue to explore the ins and out of The 255 Framework.
If you enjoyed today’s episode, make sure to subscribe to Spotify, Apple Podcast, Youtube so you don’t miss any upcoming episodes.
And if you have questions or topics you’d like me to cover, reach out to me via LinkedIn - Arnold Shields.
I’d love to hear from you and include your questions in future discussions.
Once again, I’m Arnold Shields, and this is "The 255." Thanks for listening, and I’ll see you next time.