What is Financial Risk?
Financial risk can be defined as any peril that can bring about the loss of capital to interested groups or stakeholders. For governments, this can mean that they can’t manage monetary policy and default on bonds or other debt issues. Corporations likewise face the chance of default on debt they attempt yet may also encounter disappointment in an undertaking that causes a financial burden on the business.
Financial markets face financial risk because of different macroeconomic powers, changes to the market interest rate, and the chance of default by sectors or huge corporations. Individuals face financial risk when they settle on choices that may endanger their income or capacity to pay a debt.
Financial risks come in numerous shapes and sizes, influencing almost everybody. Thus, you must be aware of the different financial risks. Realising the dangers and learning how to dispose of the risk can moderate the havoc they wreak and lessen the odds of an adverse result.
What are the different kinds of financial risks?
1. Market risk
The term market risk, otherwise called systematic risk, alludes to the vulnerability related to any investment choice. Price instability regularly emerges because of unforeseen changes in factors that ordinarily influence the whole financial market.
Systematic risk isn’t explicitly connected with the company, or the industry one invests in – all things considered, it is reliant upon the performance of the whole market. Thus, it is important for an investor to watch out for different macro factors that influence the financial market, like inflation, interest rates, the balance of payments circumstance, fiscal deficits, international variables, and so forth.
2. Credit risk
Credit risk is the risk of loss that may happen from the non-fulfilment of a party to comply with the terms and conditions of any financial agreement, especially the inability to make required payments on loans because of an independent entity. Credit risk denotes or measures the creditworthiness of a borrower.
In figuring credit risk, lenders measure the probability of whether they will recuperate the entirety of their principal and interest when providing a loan or investment. Borrowers viewed as a low credit risk are charged lower interest rates. Lenders, investors, and other counterparties counsel rating agencies to assess the credit risk of working with organisations.
3. Operational risk
Operational risks are regularly connected with dynamic decisions that identify how the organisation functions and what it prioritizes. While the risks are not ensured to bring about failure, lower production, or higher overall costs, they are viewed as higher or lower based upon different inner management decisions. Since it reflects man-made strategies and thinking measures, operational risk can be summed up as a human risk – it is the risk of business operations bombing because of possible human errors.
Operational risks change from one industry to another and are considered when deciding on potential investment strategies.
4. Liquidity risk
Liquidity is concerned with the simplicity with which an asset (equity shares, debentures, etc.) can be exchanged in the stock market in return for currency. Therefore, liquidity risk portrays the risks related to such exchanges, as the fruitful transformation of stock into cash relies upon different factors.
Ordinarily, high liquidity risk shows that a particular asset cannot be promptly purchased or sold in the market. This is because a responsible company may come across difficulties in gathering its present liabilities because of diminished cash flow.
What is financial risk management?
Financial risk management is a process of managing the vulnerabilities arising out of the operations of financial markets. It implies surveying the financial risks confronting an organisation and creating management strategies to mitigate the same in accordance with its internal policies and objectives.
Tending to financial risks proactively may give an organisation a competitive edge. It also guarantees that management, operational staff, stakeholders, and the board of directors are in concurrence with central points of contention of risk. Managing financial risk requires settling on organisational decisions about satisfactory risks versus those that are definitely not.
Organisations manage financial risk by leveraging an assortment of strategies and items. It is critical to see how these items and strategies work to diminish risk inside the setting of the organisation’s risk resistance and goals.
Financial risk vs Business risk
A company’s business risk alludes to the risk that influences the company’s business value, whether it be by means of loss of market share, or by new contestants who obliterate the business, or by the prevalent market rivalries among companies. However, financial risk is where the company fails to manage its funds due to liquidity risk, or market risk or because it could not deal with the business’ pressing interests in time.
Business risk can be characterised as the risk of whether the proprietor/s can maintain the business in the long haul or not. In simple words, it indicates the possibility of a company making lower profits due to market uncertainties, including changes in the taste and preference patterns of customers, increased market competition, etc.
Financial risk is when the company does not have the option or position to repay its debt. At the point when a firm needs to improve its financial influence by permitting the debt to go into their capital structure, they experience the ill effects of financial risk. Financial risk is directly proportional to how much debt you permit into your capital structure.
Why is it important to know about financial risks?
Financial risk, in itself, isn’t naturally fortunate or unfortunate; characterised however, just exists to various degrees. Obviously, “risk” by its very nature has an unfortunate underlying meaning, and financial risk is no exemption. A risk can spread from one business to influence a whole sector, market, or even on a global scale.
While it isn’t a positive attribute, understanding the chance of financial risk can prompt better, more educated business or investment choices. Surveying the degree of financial risk related to security or asset decides or sets that investment’s worth.
If you wish to develop your business’ portfolio or market standing, you must incur risks from time to time. And while every financial risk may not be in your control, you can of course use your industry knowledge and latest technological tools to avoid such risks, at least to a certain extent. For instance, if you use myBillBook, you can better control your financial operations by monitoring and tracking them. myBillBook helps simplify your business operations, generate real-time business reports, monitor your accounts payable and receivable, and much more!