FINANCIAL RISK MANAGEMENT

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Risk is inherent in any business operations, and good risk management is essential to identify and stop any form of revenue leakages from the business. Out of the various types of risks a business can face, financial risk has the most immediate impact on cash flows.
Financial risk is practical to businesses, government entities, the financial market as a whole, and the individual and evident when a company’s money flow is inadequate to meet its obligations.
Therefore a company with a relatively higher level of debt financing carries a higher level of financial risk since there is a greater possibility of the company not being able to meet its financial obligations and becoming insolvent.
Financial risk also refers to the possibility of a government losing control of their monetary policy and being unable or unwilling to control inflation and defaulting on its bonds or other debt issues. Governments issue debt in the form of bonds and note to fund wars, build bridges and other infrastructure and pay for its general day-to-day operations.
Several types of financial risk are tied to financial markets and many circumstances can impact these markets. As demonstrated during the 2007-2008 global financial crisis, in this situation a critical sector of the market struggled to impact the monetary wellbeing of the entire marketplace. During this time, businesses closed, investors lost fortunes, and governments were forced to rethink their monetary policy.
Individuals can face financial risk when they make poor decisions. This peril can have wide-ranging causes from taking an unnecessary day off of work to investing in highly speculative investments. Every activity has exposure to pure risk—dangers that cannot be controlled.
However, financial risk is managed differently by various institutions based on what it does, what market it operates in and the level of risk it is prepared to accept. In today’s financial world, risk management is basically the process of identification, analysis and mitigation of uncertainty in investment decisions.
Essentially, risk management occurs when an investor or fund manager analyses and attempts to quantify the potential for losses in an investment and then takes the appropriate action (or inaction) given his investment objectives and risk tolerance.
To ensure a suitable risk management, an organization must first identify and understand its financial risk exposures, its causes, and significance. A good place to start is with the company’s balance sheet. This provides details of the debt, liquidity, foreign exchange exposure, interest rate risk, and commodity price vulnerability the company is facing.
The financial risk manager of an organization should also examine the income statement and the cash flow statement to see how income and cash flows fluctuate over time, and the impact this has on the organization’s risk profile.
In risk management, it is important to quantify or put a numerical value on the risks identified. By nature, it is important to measure the financial impact of the risk factor in order to determine if it is necessary to do something about managing against the risk.
Analysts tend to use statistical models such as the standard deviation and regression method to measure a company’s exposure to various risk factors. For small businesses, computer software like Excel can help to run some straightforward analysis in an efficient and accurate way. The general rule is the greater the standard deviation, the greater the risk associated with the data point or cash flow you’re quantifying.
The final step is to decide whether to hedge each of the significant exposures. This decision is based on factors such as the business’ objectives, environment, its appetite for risk and whether the cost justifies the reduction in risk.
Generally, a few other steps to consider comprises reducing cash-flow instability, fixing interest rates on loans so that there is more certainty in financing costs, managing operating costs, controlling payment terms, putting rigorous billing and credit control procedures in place, saying farewell to customers who regularly abuse credit terms and ensuring that right people are given the right jobs with the exact amount of supervision, to reduce the risk of fraud.
In a small business, the owner and managers are responsible for risk management. It’s only when the business grows to include multiple departments and activities that there will be need for a dedicated Financial Risk Manager to manage risk and make recommendations for action on behalf of the company.
Also financial institutions must set out the right apparatuses and procedures that will be utilized to manage those exposures. Monetary chance administration does not come cheap, but it is less costly than the elective.
All organizations confront money related dangers, and their capacity to achieve their purposes depends on how well they oversee those risks. It is in this manner, a basic necessity to set up a system that would ensure effective risk management.


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