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Major Kinds Of Financial Risk(s) That Companies Face

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financial risk

What Is Risk?

The possibility of experiencing an unexpected outcome is a risk. Risk is unavoidable in any business, and this is why financial experts advise companies to have good risk management, as good risk management is an integral part of running a successful business.

While a company can directly manage certain risks, other risks are way beyond the company’s control. The best thing to do most times is to expect or foresee possible risks, assess the probable influence on the company’s business, and organize a plan to react to hostile events.

Risks in the business refer to any situation or event that can prevent the achievement of business objectives or business goals.

There are four types of risks in business. Before anyone can control or deal with risk in business, there is a need to apprehend the type of risk the business faces. The four types of risks in business are listed beneath:

  1. Financial risk
  2. Strategic risk
  3. Operational risk
  4. Compliance and regulatory risk

Understand Financial Risk; Importance Of Having Knowledge Of Financlal Risk

Financial risks are unexpected outcomes faced by a business or organization regarding handling its finance(s). Examples of financial risks are delay in delivery of goods, failure to ship inventory, lack of information needed for decision making, inadequate cash flow management, defaulting on loans, alterations in the exchange rate or interest rate, customers failure to pay for purchases, ineffective management, investments or market transactions with an increased level of vulnerability.

Financial risk could be understood when viewed as the possibility of experiencing a negative or unexpected outcome resulting from changes in the market.

Major Kinds Of Financial Risk(S) That Companies Face

There are different ways to classify a company’s financial risk; from experiences and observations, there are four major kinds of financial risks that most companies out there contend with. These kinds of financial risks would be examined here;

  1. Operational risk:

This type of financial risk emanates from a company’s daily activities. Operational risks include crime, fraud, corruption likewise, personnel issues. Operational risks occur due to mismanagement, absence or inadequate control within the company, technological delinquencies, employee training, and human error.

Operational risks are difficult to measure objectively, and they always result in financial loss. To accurately calculate operational risk, the company needs to create a history log containing failures linked to operational risks, and then, the company is to discern the possible connection between these failures.

Operational risks are categorized into two, the model risk, which concerns the company’s strategy to improve and develop; growth, and marketing. If the company’s strategy is not deliberated adequately, it could lead to a financial crisis. Operationalized risk is also categorized as a fraud risk, which refers to incapable economic behavior or fraudulent activities within a company. Fraud risks compromise a company’s integrity; an effective way to deal with fraud risk is employing a voided check; the confidentiality of a private business or company’s information is important. A handy way to protect your company is through a voided check. Protect your company from fraud and identity theft by issuing voided checks when you give out your company’s private information.

  1. Liquidity risk:

A company’s liquidity must be considered in financial risk management, and every company needs to ensure that there is enough cash flow to lay off its debts. The possibility that a company would not be able to meet its commitment is liquidity risk. A major cause of liquidity risk is inadequate poor cash flow management.

Liquidity risk relates to a company’s daily cash flow, and it also concerns how easily a company can convert assets to cash when the company needs funds. Liquidity risks are classified into operational funding liquidity risk, which refers to a company’s day-to-day cash flow.

Effective and adequate cash flow management is important for the success of every business; this is a major factor behind investors’ and analysts’ focus on standards or metrics such as free cash flow when they evaluate a company as an equity investment.

Liquidity risks are also classified as asset liquidity risk and funding liquidity risk, and asset liquidity risk refers to the comparable ease by which a company can convert its assets to change if the company is in dire need of more cash flow. Companies need assets that don’t take long to convert to cash, and this is why companies verify if they have current assets that can be converted to lay off short-term commitments.

Funding liquidity risk concerns the business’ daily basis cash flow operations. Liquidity risks are very intense; in extreme circumstances, liquidity risk results in the closure of the business.

  1. Market risk:

This is one of the most important types of financial risks; due to the dynamics of demand and supply, this type of risk has a very vast scope. Market risks are encountered due to altering conditions in a specific marketplace a company competes in for business. Market risks are the risk of being evaded by a competitor, this type of risk is largely influenced by economic uncertainties.

  1. Credit risk:

Credit risk refers to the possibility wherein a creditor receives a loan credit late or doesn’t receive the loan payment at all. This type of risk is dependent on the debtor’s capability to fulfill the loan payments obligation. A company can encounter this risk when it extends credit facilities to its customers. When a company finances a customer’s payment, the business faces a financial risk as the customer whose financed purchase could back out on a payment or delay payment.

Credit risk is divided into two types, retail credit risk and wholesale credit risk.

Retail credit risk refers to financial risk or pitfalls where a company finances an individual or smaller business. Retail credit risk is a sort of relationship between individual or smaller businesses.

On the other hand, wholesale credit risk ensues from the company or business investments; this could be the acquisition of companies, sales of a financial asset, or managers.

Risks and failures cannot be ignored in business. This does not imply that business owners should be afraid; no, the most important thing is to identify and assess these risks, resulting in failure and creating effective financial risk management to avoid or correct failure.

To control credit risk, the company should efficiently handle its credit obligations via substantial cash flow to its payable accounts bills, which must be considered on time. Failure to comply with the terms of the loan results in severe penalties, which should be avoided. Credit risks can affect shareholders and investors, and a company must protect its shareholders and investors.

On A Final Note

Companies would encounter financial risks different from each other; financial risks that a company might encounter depend on the company’s activities. However, the most important thing is to identify potential financial risks a company might encounter then assess the impact of the financial risk. Some financial risks are out of one’s control; when you open a business, make sure you open a bank or register for an insurance policy that could provide adequate and efficient cover for certain types of financial risk.

 

We are a team of writers passionate about innovation and entrepreneur lifestyle. We are devoted to providing you the best insight into innovation trends and startups.

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