What is Financial Risk?
In short, financial risk is any type of risk that is associated with financing. This includes financial transactions with company loans in risk of default. It includes only downside risk, which is the potential for financial loss. It is one of the high-priority risk types for every business.
Cash flow is the lifeblood of a business. This is the money that is coming in through accounts receivable and going out through accounts payable. This flow can be greatly affected by financial risks and create sudden losses that would greatly impact your ability to manage your financial obligations. These risks can be classified into three types: Business Risk, Non-Business Risk, and Financial Risk.
1. Business Risks are taken by business enterprises in order to maximize shareholder value and profits.
2. Non-Business Risks are out of the control of the firm. These risks arise because of economic and political imbalances.
3. Financial Risks are any risks of financial loss to the company. These are usually due to instabilities and losses in the financial market that are caused by movements in stock prices, currencies, interest rates, and more.
Types of Financial Risk:
There are four major types of risks that fall under the financial risk category. This category is for risks that specifically affect a business’s cash flow. The four major types are:
· Market risks which are based on how changes to the business environment may affect how you do business. Market risks can fall in to two categories: directional risks and non-directional risks. A directional risk is caused by movement in stock prices, interest rates, and more. Non-directional risks are volatility risks.
· Credit risks are risks that come from extending credit to clients who do not pay.
· Liquidity risks refer to a company’s ability (or lack-thereof) to quickly convert assets to cash.
· Operational risks are the risk that operational failures may occur. These include mismanagement, fraud, and technical issues.
How to Analyze Financial Risk
Analyzing financial risk is crucial to every business. A financial risk assessment can help you identify the risks that are specific to your business, prioritize the risks, and develop ways to manage them if they should occur. A financial risk assessment can also help you understand how likely these situations are to occur.
The first step to analyzing your financial risk is to identify what financial risks exist. To identify the financial risks, you need to start reviewing your corporate balance sheet or statement of financial position. The goal is to understand what your business’s main sources of revenue are and how customer credit terms affect this revenue.
Once you know what financial risks exist, you need to begin to analyze the likeliness that these risks may occur, and what the consequences of their occurrence would mean for your business. It is important to check in on your profit margins. Healthy profit margins provide a buffer and allow you to absorb any impacts to your cash flow with less damage to your business.
To analyze each risk, ask yourself:
1. What is the likeliness this risk will occur?
2. If this happens, how much of an impact would it have on the business?
3. What steps can the business take to recover and how long would it take?
4. What can the business do to prevent and prepare for this risk?
Create a Plan
After analyzing the financial risks of your business, it is time to prepare for those challenges.
At Impello Global, we offer Trade Credit Insurance, which is also known as Accounts Receivable Insurance. This risk management tool protects your business from domestic and foreign customer insolvency.
Contact us today to learn more about how we can help you protect your company from financial risks.