An Assessment of Financial Risks
Risk is as an aspect
that organizations cannot avoid due to the investment decisions that companies
make often. Financial risk occurs when organizations lose funds due to
instability in the financial market as a result of increased interest rates,
changes in currencies and also stock prices. Some aspects of risk can are
controllable, but others are uncontrollable. For organizations to manage risks
and avoid loss of funds, they anticipate the risk, in advance, assess their
impact, and then come up with a plan to counter the threat. Thus, scholars have
invested resources and time to find the meaning of financial risk concepts and
the impact they have on the organization.
Market risk
Market risk involves a
decrease in the value of assets and liabilities as a result of uncontrollable
market factors. According to Zhukov
(2018), it is the risk of a loss due to unstable price changes. Risk associated
components include currency risk, where the exchange rates might increase or
decrease. Additionally, Equity risk as a market risk involves the possibility
that the share prices in the company an organization has invested in may go up
or down. Moreover, inflation risk might also occur, such that the value of
money might fluctuate, causing businesses to experience losses. Additional risk
components include interest rates risk and commodity risks, where prices have
dramatic changes such as metals. In addition to the fluctuation of prices,
other changes in the market that organizations operate result in market risk.
For example, the tremendous shift from retail operations to online stores is a
market risk for organizations that still operate retail stores. Competitors who
serve in the same industry can also pose as market threats. Other market risks
include natural disasters and even recessions.
Since market diversification, cannot solve market risks,
its effects are dominant. They can happen during a short period causing
significant loses and in severe cases might lead to the collapse of a business.
Interest rates of companies affect the structure of the balance sheet and the
income statement, which are very crucial in the operation of a business.
Additionally, fluctuating interest rates and currency fluctuations harm
organizations profits. Currency risk, as a market risk has detrimental impacts
on a company’s earnings.
Liquidity Risk
Liquidity risk
transpires when organizations are unable to achieve short term financial
demand. The risk occurs because companies are not able to covert company assets
into cash, without losing a substantial amount of income in the process. In
liquidity risk, an inefficient market makes organizations lack buyers of the
asset at the current market value.
Risk associated
component includes market and funding liquidity. In market liquidity,
organizations are unable to convert assets into cash due to poor market
conditions quickly. Despite the asset having value, it is not recognizable at
that time, and it can also be sold at a lower price or discounted. Funding
liquidity is associated with low operating cash flows whereby organizations are
unable to pay their bills on time due to insufficient funding. A company’s
obligations are more than the existing cash flows, hence a liquidity risk. To
measure liquidity risk, companies adopt current ratio by dividing current assets
by liabilities. Additionally, use quick ratio is of applicable which divides
accounts receivables, marketable securities and total cash by the current
liabilities.
Liquidity risk
management is crucial as companies can if the company cannot quickly convert assets
into cash when the company needs it most. Any funds left can be used to grow
the company or as dividends to shareholders. Companies can also be able to
avoid potential loss. (Lombardi et al., 2016). In addition to affecting the global
economy due to the lack of cash flow, companies are now adopting liquidity risk
management to avoid financial distress.
Credit Risk
Credit risk is the loss
experienced by organizations as a result of extending credit to its customer
and also the company’s credit risk with its suppliers. According to Svetlova & Thielmann, (2020), it may also refer to a situation where the lender will
not be able to receive both principal and interest. Credit risk associated
components include credit spread risk, default risk and downgrade risk. Credit
risk is the possibility of loss due to the fluctuations in the investment
interest rates. Default risk arises when the borrower is not able to make
payments as per the contract stipulations.
Downgrading risk is associated with the risk rating of the issuer. For organizations to minimize the credit rate, they should calculate the FICO score of the customer. A company should also conduct a debt-to-income ratio. An analysis is done by dividing the company’s monthly recurring debts by the gross monthly income. Credit risk in the organizations interrupts cash flow while increasing the costs for collection. Additionally, defaulting supplier payment may result in adverse publicity; the suppliers may stop extending credit or even refuse to do business with the organization. Effective credit risk management helps organizations to serve customers better, mitigate losses and also maintain a good rapport
Operational Risk
Operational risk is a possibility of loss in the daily
business activity set –up due to unsuccessful procedures or policies in the
organizations. The risk can occur in all organizations. Broadly categorized the
dangers associated with operational risk include external risk, people risk,
process risk and system and technological risks. According to Cooperman (2016), external threats involve those that the organization does
not have control such as fraud, money laundering as well as natural and
non-natural disasters. People risk include errors associated with employees
such as discrimination, health and safety of employees, errors of omission,
loss of key people and also loss of suppliers. Process risk comprises of
mistakes in business operation and product failure. Technological risks are
associated with IT systems and even the threat of online fraud.
Operational risk has been on the increase due to
technological advances and the many mergers, especially in the banking sectors.
Operational risk is mostly within the control of the organization. Operational
risk lead to higher levels of operating losses either directly or indirectly,
and in the extreme causing organizations to be bankrupt. It also leads to
reduced profits, lowers production, and increases overall costs of operation,
making business operations challenging.
Conclusion
Financial risks affect
all organizations, and it is essential to embrace risk management procedures to
counter threats. Organizations must incorporate emerging factors such as
technology when developing risk management strategies. Companies will achieve a
competitive advantage while avoiding the risk of enormous losses and becoming
obsolete.
An Assessment of Financial Risks
Risk is as an aspect
that organizations cannot avoid due to the investment decisions that companies
make often. Financial risk occurs when organizations lose funds due to
instability in the financial market as a result of increased interest rates,
changes in currencies and also stock prices. Some aspects of risk can are
controllable, but others are uncontrollable. For organizations to manage risks
and avoid loss of funds, they anticipate the risk, in advance, assess their
impact, and then come up with a plan to counter the threat. Thus, scholars have
invested resources and time to find the meaning of financial risk concepts and
the impact they have on the organization.
Market risk
Market risk involves a
decrease in the value of assets and liabilities as a result of uncontrollable
market factors. According to Zhukov
(2018), it is the risk of a loss due to unstable price changes. Risk associated
components include currency risk, where the exchange rates might increase or
decrease. Additionally, Equity risk as a market risk involves the possibility
that the share prices in the company an organization has invested in may go up
or down. Moreover, inflation risk might also occur, such that the value of
money might fluctuate, causing businesses to experience losses. Additional risk
components include interest rates risk and commodity risks, where prices have
dramatic changes such as metals. In addition to the fluctuation of prices,
other changes in the market that organizations operate result in market risk.
For example, the tremendous shift from retail operations to online stores is a
market risk for organizations that still operate retail stores. Competitors who
serve in the same industry can also pose as market threats. Other market risks
include natural disasters and even recessions.
Since market diversification, cannot solve market risks,
its effects are dominant. They can happen during a short period causing
significant loses and in severe cases might lead to the collapse of a business.
Interest rates of companies affect the structure of the balance sheet and the
income statement, which are very crucial in the operation of a business.
Additionally, fluctuating interest rates and currency fluctuations harm
organizations profits. Currency risk, as a market risk has detrimental impacts
on a company’s earnings.
Liquidity Risk
Liquidity risk
transpires when organizations are unable to achieve short term financial
demand. The risk occurs because companies are not able to covert company assets
into cash, without losing a substantial amount of income in the process. In
liquidity risk, an inefficient market makes organizations lack buyers of the
asset at the current market value.
Risk associated
component includes market and funding liquidity. In market liquidity,
organizations are unable to convert assets into cash due to poor market
conditions quickly. Despite the asset having value, it is not recognizable at
that time, and it can also be sold at a lower price or discounted. Funding
liquidity is associated with low operating cash flows whereby organizations are
unable to pay their bills on time due to insufficient funding. A company’s
obligations are more than the existing cash flows, hence a liquidity risk. To
measure liquidity risk, companies adopt current ratio by dividing current assets
by liabilities. Additionally, use quick ratio is of applicable which divides
accounts receivables, marketable securities and total cash by the current
liabilities.
Liquidity risk
management is crucial as companies can if the company cannot quickly convert assets
into cash when the company needs it most. Any funds left can be used to grow
the company or as dividends to shareholders. Companies can also be able to
avoid potential loss. (Lombardi et al., 2016). In addition to affecting the global
economy due to the lack of cash flow, companies are now adopting liquidity risk
management to avoid financial distress.
Credit Risk
Credit risk is the loss
experienced by organizations as a result of extending credit to its customer
and also the company’s credit risk with its suppliers. According to Svetlova & Thielmann, (2020), it may also refer to a situation where the lender will
not be able to receive both principal and interest. Credit risk associated
components include credit spread risk, default risk and downgrade risk. Credit
risk is the possibility of loss due to the fluctuations in the investment
interest rates. Default risk arises when the borrower is not able to make
payments as per the contract stipulations.
Downgrading risk is associated with the risk rating of the issuer. For organizations to minimize the credit rate, they should calculate the FICO score of the customer. A company should also conduct a debt-to-income ratio. An analysis is done by dividing the company’s monthly recurring debts by the gross monthly income. Credit risk in the organizations interrupts cash flow while increasing the costs for collection. Additionally, defaulting supplier payment may result in adverse publicity; the suppliers may stop extending credit or even refuse to do business with the organization. Effective credit risk management helps organizations to serve customers better, mitigate losses and also maintain a good rapport
Operational Risk
Operational risk is a possibility of loss in the daily
business activity set –up due to unsuccessful procedures or policies in the
organizations. The risk can occur in all organizations. Broadly categorized the
dangers associated with operational risk include external risk, people risk,
process risk and system and technological risks. According to Cooperman (2016), external threats involve those that the organization does
not have control such as fraud, money laundering as well as natural and
non-natural disasters. People risk include errors associated with employees
such as discrimination, health and safety of employees, errors of omission,
loss of key people and also loss of suppliers. Process risk comprises of
mistakes in business operation and product failure. Technological risks are
associated with IT systems and even the threat of online fraud.
Operational risk has been on the increase due to
technological advances and the many mergers, especially in the banking sectors.
Operational risk is mostly within the control of the organization. Operational
risk lead to higher levels of operating losses either directly or indirectly,
and in the extreme causing organizations to be bankrupt. It also leads to
reduced profits, lowers production, and increases overall costs of operation,
making business operations challenging.
Conclusion
Financial risks affect
all organizations, and it is essential to embrace risk management procedures to
counter threats. Organizations must incorporate emerging factors such as
technology when developing risk management strategies. Companies will achieve a
competitive advantage while avoiding the risk of enormous losses and becoming
obsolete.
References
Cooperman, E. S. (2016). Managing financial institutions: Markets and sustainable finance. Taylor & Francis.
Lombardi, R., Coluccia, D., Russo, G., & Solimene, S. (2016). Exploring financial risks from corporate disclosure: evidence from Italian listed companies. Journal of the Knowledge Economy, 7(1), 309-327.
Svetlova, E., & Thielmann, K. (2020). Financial Risks and Management. International Encyclopedia of Human Geography.
Zhukov, P. E. (2018). The impact of financial risk and volatility to the cost of debt, and the average cost of capital. Journal of Reviews on Global Economics, 7, 865-871.