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For companies and their investors, identifying and reacting to risks is crucial. Some risks are more critical than others. Usually, companies or investors need to investigate those promptly. Among these businesses, risk and financial risk are often prevalent. There are some differences between both, however, which is necessary to understand.
What are Business Risks?
Business risk refers to any risk that exposes a company or business to lower profits or even losses. These risks can come from several sources. Usually, these come from within the company from internal factors. However, external factors can also play a role in creating them. In short, business risks come from anything that threatens a company’s ability to generate wealth for its shareholders.
Business risks are manageable when they are internal. However, when caused due to the environment that a company operates in, it may be impossible to manage. Nonetheless, companies can use various techniques to mitigate these risks. These are part of a company’s risk management strategies.
Internally, business risks arise due to a direct result of the decisions made by a company’s management. For example, if a company changes the price of its products or its product mix, its profits may decrease. Mostly, internally-generated business risks affect only the company that makes these decisions. Similarly, it will impact the company’s stakeholders as well.
Externally, business risks come due to a number of reasons. These may include political, economic, social, or technological factors, among other things. For example, a change in consumers’ demands or a rise in its competition can affect the company. Usually, external factors also extend to the industry or market in which a company operates.
What are Financial Risks?
Financial risks are a type of business risk. They entail the risk of a company losing money on its investments, projects, or business ventures. As a result, the company’s profits will also take a hit. Therefore, financial risk comes with business risk. There are more types of financial risks that companies must bear. These include operational, liquidity, or credit risks.
Financial risks, like business risks, can arise from internal or external factors. It can result in the loss of capital for a company’s stakeholders. Financial risks may also extend to other entities, even ones that don’t focus on making profits. Similarly, financial risks may also spread to financial markets due to various macroeconomic factors.
Although a type of risk, financial risks aren’t necessarily a bad thing. Identifying the source of financial risk and understanding it can be beneficial for companies. It allows them to make more informed decisions about their future projects. Financial risks also come with higher rewards. Therefore, taking these risks can also create wealth in the long run.
For companies, financial risks are mostly controllable. Through the use of analytical, fundamental, and quantitative analysis, companies can identify and analyze these risks. These may also include using ratios or specific techniques to minimize these risks. Similarly, for companies, decreasing their leverage can also reduce the related financial risks.
Conclusion
Companies face various risks during their operations. Business risks refer to any risks that can affect a company’s profitability. These may either reduce a company’s profits or result in losses. Financial risk is a type of business risk that refers to the risk of losing money on investments. These usually relate to a company’s finance structure.
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