Financial risk is the risk that businesses run into when making investments or when conducting day-to-day operations.
Monty is a car mechanic running his own business from a garage in his neighbourhood. He has to consider a range of risks that come with owning and running such as business. All of the risks that he identifies may potentially affect his ability to make money, which mean that they ultimately lead to financial risk.
For Monty, factors influencing financial risk like market changes, government regulations, credit use and liquidity are major.
If fewer people are buying cars, then the need for his services may dwindle. The fact is that if there are no cars to service, then there is no demand for his services. Market risks present themselves in the form of changes based on supply and demand, technology or consumer interest.
If government decides to impose strict regulations about where businesses like his can operate in residential areas, this will have a direct impact on his finances.
Credit risk for Monty relates to the current financial standing of his company. If Monty provides services to some of his clientele on credit, he expects payment to be made as promised. If this isn’t done, then his financial standing is affected negatively, which may lead to his business having difficulty servicing its credit agreements.
Liquidity refers to how much cash the business has kept aside for emergencies. If Monty’s business has no form of liquidity, this poses a financial risk. Cash flow is also determined by daily revenue and expenses.
Economic changes that may lead to financial risk are often unforeseen. This includes inflation, taxes and fluctuating markets.
Understanding the various factors influencing financial risk is an important part of running any business efficiently.