Every business on the run is susceptible to risk. Over the centuries, financial risk has managed to pull down many institutions, coming out in different forms based on the strategies and operations of the organization. Therefore without formulating a plan of how to curb or solve it, you are likely to face a tough time recuperating yourself back to the top.
Risks may differ based on where it is incurred. A case where it is a general issue that any department or personnel may handle is manageable. However, on the corporate level, there are likely to pose some severe scenarios that require professionals. In this particular article, we will delve deep into articulating what is meant by financial risks.
Financial risk is understood as the ability of the firm to be able to manage its debts and accomplish their financial obligations. It is the chances of having an unfortunate or unexpected outcome based on the financial operations of the firm.
In most cases, the financial risks are caused by situations as such as hiking of the interest rates, exchange rates, instabilities in the economy, losses in the financial markets as a result of the movement of stock prices to mention a few. The financial risk management department handles this type of risks.
These managers are tasked with the duty of comprehending the techniques to control the risk and perform risk management assessment in case such situations are incurred in the future.
Financial risk management majors extensively on the costs of financing and the amount of debt incurred by the business during its financial operations. For you to understand financial risk effectively, we'll separate the theme subject into four diverse categories.
This type of risk is incurred due to the volatile movement of market prices, hiking of the exchange, and interest rates that lead to financial market losses. Changing conditions in the marketplace have significantly caused a stir among traders and corporate professionals. Movement of the financial instruments can further be categorized as either directional or non-directional risks, respectively.
Directional risks can be explained as risks being aggravated by the movement of financial instruments like stock prices, interest and exchange rates, to mention a few. Non-directional risks, on the other hand, are incurred as a result of the volatility of the market. Market risk may force a firm to be outmaneuvered by its competitors in several ways.
For example, many banking systems aim at improving their services to comply with their clientele's satisfaction. By formulating mobile and desktop applications for faster access to money, they can attract new customers from their competitors who still rely on traditional means.
This is a kind of risk whereby firms incur as a result of extending their credit service to their clients. Organizations may bear a risk of failing to pay their creditors as a result of default from their customers. This may also result from a company purchasing credit goods from their suppliers.
To avoid such scenarios in the future, they need to have a consistent cash flow system that can be used to cater for their accounts payable to cover the firm's bills. Credit risk is likely to spoil the reputation of the firm, thus losing clientele and at the same time losing suppliers.
Without a proper cash flow system, the firm is likely to lose a lot of clients and suppliers. This directly affects the firm's image in the marketplace. Operational risk involves the loss incurred by the firm as a result of the adverse effects of the policies, operations, and procedures that are within the entity.
This likelihood may be as a result of issues like fraud, lawsuits, unethical environment among the staff, poor business models, to name a few. These risks portray the inaccuracy and unreliability of the financial institution.
These types of risks are incurred due to a failure of the firm to meet their short term obligations to enable them to execute their day-to-day transactions. It involves the daily flow of cash and asset liquidity. Asset liquidity means the relative ease in which the organization can convert their assets into cash.
The urge to convert the assets to cash may be urgent in situations where a problem has occurred, or a sudden urge to increase the substantial cash flow is recommended. Liquidity risk is likely to hit the firm hard in times of urgency, for instance, paying for the inevitable expenses in the business.
Consider that it is vital for every entity, be it a well-established business or a new entrant in the market, to incorporate techniques that will aid in managing these risks. Failure to doing this shortens the entity's life-line in surviving the harsh market.
You need to identify and measure the risks likely to be experienced. This can be done using financial instruments like the beta coefficient in calculating the volatility of the market. The financial risk managers also need to know which level of risk they are willing to accept or handle.
The business should ensure that they formulate effective policies that aim to control the means at which credit services are offered to customers. This can be done via thorough scrutiny of the client's credentials and acquisition of securities. This gives the business confidence that the client's chances of defaulting are minimal.
It is also essential to check on the cash flow system of the business. This ensures that the firm is capable of sorting out its expenses even in times of urgency. It is also imperative to diversify the income sources of the business. With this, the firm is likely to be at a safe level in case one of the sources stalls on the way.
From time to time, it is safe and highly recommended to assess the firm's performance and its probability of suffering to risks. This can be furnished more by adopting new methods and continuously researching new techniques to be up-to-date.
Regular spot checking of the risks keep you alert in case any risk may occur. Feel free to get in touch with us today for any finance help or query regarding the subject.