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Contents
DEFINITION OF BUSINESS RISK AND FINANCIAL RISK TYPES OF BUSINESS RISK AND FINANCIAL RISK FACTORS AFFECTING BUSINESS RISK AND FINANCIAL RISK RISK MANAGEMENT RISK MANAGEMENT PLAN RISK MANAGEMENT TOOLS RISK MANAGEMENT PROCESS
Risk:
The chance that an investment's actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment. A high standard deviations indicates a high degree of risk.
Business Risk
The possibility that a company will have lower than anticipated profits, or that it will experience a loss rather than a profit. Or It is defined as the uncertainty inherent in projections of future returns, either on assets (ROA) or on equity (ROE), if the firm uses no debt or debt-like financing (i.e., preferred stock). Hence, it is the risk associated with the firms operations ignoring any fixed financing affects.
Financial Risk
It is defined as the additional risk over and above the basic business risk placed on common stockholders which results from using financing alternatives with fixed periodic payments, such as debt and preferred stock. Thus, it is the risk associated with the types of funds the firm uses to finance its assets.
Financial Risk
Direct financial risks have to do with how your business handles money. That is, which customers do you extend credit to and for how long? What is your debt load? Does most of your income come from one or two clients who might not be able to pay? Financial risks also take into account interest rates and if you do international business, foreign exchange rates.
Operational Risk
Operational risks result from internal failures. That is, your businesss internal processes, people or systems fail unexpectedly. Therefore, unlike a strategic risk or a financial risk, there is no return on operational risks. Operational risks can also result from unforeseen external events such as transportation systems breaking down, or a supplier failing to deliver goods.
Other Risks
Other risks are more difficult to categorize. They include risks from the environment, such as natural disasters. Difficulties in maintaining a trained staff that has up-to-date skills to operate your business is sometimes called employee risk management. Health and safety risks not covered by OSHA or state agencies fall into this category as do political and economic instability in countries you import from or export to.
Credit Risk
The possibility that an investment will lose value owing to declining financial strength in the underlying company is referred to as credit risk. Default risk is one component, referring to the potential for a financially weakened company to default on its payments of interest and principal to bond holders and an eventual collapse of the enterprise, which makes the stock worthless. High credit risk, whether in terms of securities investments or consumer and corporate loans, leads to high interest rates to compensate for the potential of late payments or total default.
Market Risk
Market risk refers to the risk of loss sustained as a result of changes in the values of market prices/rates or factors that drive the value of financial instruments/ transactions.
Liquidity Risk
Liquidity risk refers to the risk of loss arising from the inability to trade instruments due to the absence of counterparties or the risk of loss arising from the inability to finance or invest cash, for example, the inability to re-finance obligations as and when they mature or the inability to refinance at anticipate rates.
Risk Management:
Risk management is a scientific approach to dealing with pure risks by anticipating possible accidental losses and designing and implementing procedures that minimize the occurrence of loss or the financial impact of the losses that do occur.
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