Financial risk is usually related to many small businesses. Small business owners are at constant risk of losing large sums of money. These losses occur when they are using debt financing to open and run their business.
This financial risk may also be related to investments that are done in other companies. Here is a complete guide on what financial risk is, how it is measured, and the types of risks.
What is financial risk?
Financial risk is a type of risk that is inherent in the investment for any business. This risk applies to all the government, individual and financial markets.
A business will face this risk when it is not able to pay back its debt and reach the obligations set. Investors might even lose the money that they have invested in the business due to this risk.
The more debt that your business is in, the higher is the financial risk.
What does it mean by financial risk management?
Financial risk management is nothing but dealing with the uncertainties that arise from financial markets. This management plan attempts to analyze and see the financial risk facing the business or organization is done.
Later, management strategies are developed in line with the internal policies and priorities to avoid financial risk. These strategies that are devised for risk management mostly include derivatives.
You can choose to take a business loan to help you with the situation, but that will not bring back your lost money.
How does this financial risk even arise?
There are three main sources due to which the financial risk arises. Those three are mentioned below:
- Some financial risks arise due to the organization’s plans in changing market prices like the exchange rates, commodity prices, and interest rates. This will cause uneven revenue and disrupt the business’s ability to pay back debt.
- Sometimes, these risks may even arise from the transactions. During the derivatives transactions that occur with other organizations such as counterparts, these risks may occur.
- Lastly, the financial risk may even arise from the organization’s internal failures. For example, the risk may be from a process, a person’s failure, or even the system.
How to measure the financial risk?
There are two ways in which you can measure the financial risk, which are explained below:
- Data and analytics: It is important to analyze the business risk for your organization to avoid failure and losses. Every business runs on data. If you want to analyze the financial risk for your business, you need to leverage the internal data of your business and complement the external data. This will help you measure the financial threat to your business.
- Artificial Intelligence ( AI ) and Machine Learning ( ML ): These days, IT calculations are taking over to help every kind of business manage their accounts. These calculations will help the business to decide in taking a risky decision. Artificial Intelligence and Machine Learning technologies lead to making all the analytical decisions at greater accuracy and speed.
If you own a business, you must know that many businesses are prone to different kinds of risk with varying threat levels. You need to identify the type of risk that may arise in your business beforehand and implement necessary precautions to help your business grow.
Types of financial risks
The following are some of the types of financial risks:
- Credit risk: In any organization, credit risk occurs when you cannot pay the creditor. For example, if you cannot pay back the bank or lender after taking a business loan, it is considered a credit risk. You might even take the credit risk by extending credit to your customers in case of default on payment.
- Liquidity risk: The liquidity risk arises if any party cannot pay or make the transaction on behalf of the business. This risk is further classified into two types. Asset liquidity risk is when there is a shortage of buyers or sellers against the counter orders. Fund liquidity risk arises when there is a lack of funds for your business.
- Equity risk: This is another type of financial risk that arises when the market becomes volatile. In a volatile market, the companies struggle to price their equity shares. Market value going down is never a piece of good news for any business. This volatility of the equity stock market is considered as equity risk.
- Operational risk: This type of risk includes all the risks your business may face in daily operations. For instance, fraud, inventory fires, poor budgeting, turnovers, inaccurate market plans are all considered operational risks. These risks can be avoided by monitoring your business closely at all times and taking preventative measures.
- Market risk: This risk depends on the market your business operates in. Market volatility, raw material costs, changes in the foreign exchange prices, and rise in interest rates cause the market risk.
- Legal risk: If you are losing finance due to legal proceedings such as a failed lawsuit, then such risk is called legal risk.
- Political risk: If the state has unstable political circumstances, your business is at high political risk. If the laws are changed overnight by the business sector your company operates in, you might face losses. Poverty, terrorism, and changes in the economy suddenly are some of the political risks.
Many ways are available for you to recover if you have to face financial risk. You can opt for a business loan and change the face of your business again with the aid provided.
You can even choose MSME registration via online portals for your small-scale business and enjoy the abundant offers and benefits that the government provides.
For details about MSME loans and MSME registrations online, contact us today. You can call us at 011 – 4310 – 9577 or write to us at firstname.lastname@example.org.
Frequently Asked Questions
Financial risk is the possibility of losing money on an investment or business venture. Financial risk is a type of danger that can result in the loss of capital to interested parties.
These are the types of financial risk:
1) Market risk
2) Credit risk
3) Liquidity risk
4) Operational risk
Financial risks are risks faced by the business in terms of handling its finances, such as defaulting on loans, debt load, or delay in delivery of goods.
Here are some of the most common ways you can properly manage financial risk:
1) Carry the proper amount of insurance.
2) Maintain adequate emergency funds.
3) Diversify your investments.
4) Have a second source of income.
5) Have an exit strategy for every investment you make.
6) Maintain your health.
7) Always read the fine print.
To identify financial risk, start by carefully reviewing your corporate balance sheet or statement of financial position. You will want to understand what your main sources of revenue are and how customer credit terms affect this revenue.
Financial Risk Management is the process of identifying risks, analysing them, and making investment decisions based on either accepting or mitigating them. These can be quantitative or qualitative risks, and it is the job of a Finance manager to use the available Financial instruments to hedge a business against them.