Financial Risk (What Is It, Types Of Risk And Ways To Reduce It)

Category: Finance

In the business world, knowing how to financially manage the company is vital for its development. To do so efficiently, it is necessary to be clear about the financial risk to which the company is exposed.

If this type of risk is not carefully considered and valued, the company may have significant losses, it is important to highlight that every company is exposed to financial risk, whether it is starting its manufacturing or service, or if it has been in business for years, event probabilities cannot be controlled externally.

What is Financial Risk?

When speaking of financial risk, it refers to the probability of certain events occurring that could affect the stability of a business or company, which would have a considerable impact on the company’s financial statements, these risks are inherent to the business, however, with Controls can mitigate the level of risk.

It also refers to the uncertainty about the returns on certain investments or financing that the company has incurred, given that due to various internal or external factors, the return on investment may not be as expected and, on the contrary, may have a lesser effect or negative.

What does Financial Risk consist of?

When the owners of the company are in charge of making an investment in shares of a company, buy fixed deposits in the market hoping to recover the capital plus interest, or acquire financing through a bank or other financial instruments, they are exposed to a risk It is inevitable that this money may not return in the way that it has been projected.

This risk is tacitly found in most of these transactions given various factors in the market, they can affect the operation of the business, liquidity, in this way the financial risk can slow down the payment of financial obligations, or the recovery of capital invested in a financial instrument from which a return is sought.

Types of Financial Risk

The fact that financial risk is present as a probability in the different transactions carried out by the company makes it difficult to quantify the number of financial risks that may exist.

However, over the years these risks have been systematized and classified so that depending on the category or activity of the company that impacts, it can be categorized, for this reason, we detail the types of financial risks one by one:

Market risk

Market risk is one of the best known and refers to the probability that a credit portfolio will be impaired, both for investments and businesses, this risk would generate an estimated deterioration in the value of said portfolio, generating a new much lesser amount or loss of an asset.

This risk has as main risk factors a change in the interest rates in said portfolios, there are also changes in the value of one currency in favor of another, that is, an increase in the value of a foreign currency and national currency that conditions the value to recover the value with which the transaction was carried out, which is usually evident in inflation.

Lastly, there may be a change in the supply and demand of certain financial instruments, as is usually the case with shares on the stock exchange, the value of which may increase or decrease depending on the reputation and demands of the shares on the market.

Operational risk

The operational risk makes mention of those problems that may arise in the daily activities that the company has, this impact is difficult to quantify given that it results from the capacity or lack of trained personnel to carry out its work and the levels of controls that the company has to reduce the risk of error.

This risk is the most controllable since it is largely based on the internal structure of the company and on the knowledge that it has of its daily operations.

Liquidity risk

Liquidity risk is one of the most complex for a company, since it determines the inability to trade both for sale and purchase of its assets.

By presenting an impairment in the portfolio and working capital of a company, its ability to meet the company’s obligations and liabilities is limited.

Credit risk

Credit risk is the expectation of the cash flows that the company expects to obtain for a transaction, the fact that one of the parties cannot comply with the payment obligation can generate setbacks and losses in the company’s ability to projection of the payment of its suppliers, the negotiation of new investments or the payment to its employees.

Legal risk

It is a financial risk associated with the change of laws, policies or governments within the country or country with which to carry out import or export transactions of products or some services, this generates high levels of uncertainty that may harm the results that the company expects to achieve. company.

How can financial risk be reduced?

In order to reduce risk, the company must implement analysis and a structured scheme for managing financial risk through management decision-making that take into account the possible losses that can be generated by making various investments and transactions. Some examples could be:

  • Analyze in detail the financial information and profitability offered by a financial instrument and its market price, in addition to historical behavior.
  • Diversify investments in a portfolio of securities that bet on different items, so that if one of the securities falls, the others can sustain the investment and reduce the loss.
  • Analysis processes and internal management of the company, linked to logical and human analyzes that allow foreseeing situations that are under the control of the company.
  • Invest in skills related to understanding finances and current market behaviors.