By Pratik Hambardiker
Outsourcing can cut costs and improve the quality of an organization’s non-core functions, enabling the firm to focus its energy on areas, where it has a competitive advantage. Consequently, numerous startups and SMEs (Small and Medium Enterprises) are outsourcing critical but non-core functions such as taxation, legal services, payroll management, financial portfolio management, and actuarial services to optimize their business processes and boost their bottom line.
However, outsourcing arrangements can become complex owing to the involvement of third parties, transferring risks that are beyond the control of firms. Consequently, before outsourcing the financial services, new businesses must take time to gauge the potential risks involved and develop controls and contingency plans to mitigate these risks.
Here are four finance-outsourcing risks that startups need to mitigate, in order to maximize the benefits of outsourcing and make profits.
1. The Hidden Costs
Before hiring an outsourcing firm, it is crucial to do a cost-benefit analysis. Evaluate the cost of maintaining an in-house finance department and the overall cost of hiring an outsourcing company.
For in-house cost assessment, consider the salaries, benefits, training, office space, equipment, and the software costs. When evaluating the outsourcing expense, ask the outsourcer to offer you a well-documented agreement that states all the deliverables, the deadlines, and the potential hidden costs.
It is crucial for you and the outsourcing company to agree mutually on the expectations, reducing the chances of any unexpected costs that can adversely affect the net profit.
2. Governance Issues
Failure to define the outsourcing arrangement may lead to ongoing operational issues and severe business disruption. Though the standards and procedures involved in a project are defined at an early stage, many times the outsourcers are unable to bridge the gap between the clients’ increasing expectations and their performance.
Most outsourcing firms use three levels of governance, namely a set of service level agreements (SLAs), provisions for improvement, and definitions of interactions between the parties. Yet, these agreements aren’t able to cover all the aspects of the governance, posing a threat to the outsourcing success and impacting the organization’s profits.
Good governance requires effectively managing the contract terms along with a new business model. Outsourcing service providers must understand their scope of responsibilities, monitor and maintain the service levels, and get involved in the organizational change management.
Make sure that the outsourcing firm has a strong governance team that includes subject matter experts. The organization’s senior management must also support the outsourcing firm with adequate resources that are required to manage the outsourcing relationship. Moreover, communication pertaining to service levels, pricing, and regular developments must be consistent and scheduled, preventing blind spots pertaining to governance issues.
3. Managing and Monitoring the Outsourcing Arrangement
When outsourcing, the firm’s focus shifts from the non-core (yet crucial) functions to the core functions. This undue reliance on the third party may prove to be risky, as a poor-quality service may severely affect the business.
Moreover, an outsourcing company has several other clients vying for its time and attention. If you have a financial project with a tight deadline, the outsourcer may skip a few crucial quality checks or perform them in a hurry, affecting the outcomes of a project.
Before hiring an outsourcing company, evaluate their existing quality assurance processes. A service level agreement defines the level and quality of service expected from the outsourcer, safeguarding your business from third-party risks.
Once you hire an outsourcing firm, conduct regular inspections and reviews to detect and correct errors, enabling you to control costs, use resources efficiently, and prevent delays.
For instance, if an outsourcing firm is managing your external reporting requirement, it is responsible for thoroughly inspecting the financial documents sent to the external stakeholders, namely the banks, the shareholders, and the general public. The stockholders too depend on the accuracy of these documents for their buying and selling decisions. Any error in these documents can adversely affect these decisions, resulting in heavy losses.
Consequently, active management and monitoring of the outsourcing relationship is a must, to ensure that your resources are being used effectively.
4. Data Security and Intellectual Property Protection
An organization’s confidential data and intellectual property (IP) can be at a huge risk when outsourcing tasks. Numerous finance-related tasks delegated to an outsourcer may require you to entrust him/her with the organization’s sensitive information.
For instance, if you are hiring an external firm for tax outsourcing services, you will have to share the information related to your company’s tax returns and financial transactions. If this information is leaked, it may cause serious damage to the corporate reputation and put its data at the risk of being misused.
Moreover, a threat to the intellectual property can expose valuable company information to outsiders, posing a significant security risk to the business.
Make sure your outsourcing company has clear enforceable policies to protect the data you share with it. Include a non-disclosure agreement, a non-compete agreement, and a non-solicitation agreement to prevent the outsourcer from mishandling your data. Furthermore, it is crucial to train your employees to share only that data, which is essential to complete the project.
For several years, organizations have outsourced key accounting and financial functions, enabling them to use resources for their core strategic business activities. However, outsourcing poses several significant risks, which if not addressed in time may result in unintended credit exposures, monetary losses, missed business opportunities, loss of customers, and damage to the firm’s reputation.
Use the above-mentioned information to mitigate the common finance outsourcing risks that your startup may face in the future.