Businesses, whether large or small, need to know how to manage finances well, for success as well as financial sustainability. It’s vital for management to understand internal and external factors that may lead to financial risk.
Financial risk comprises activities or events that may possibly affect the financial status of an individual or organisation.
Understanding the possible causes of financial risk can be a good way of ensuring that you implement preventative measures that could go a long way towards avoiding a financial crisis.
Economic risks are changes within certain industries that may result in decreased income and more expenses. Once these have been identified, it’s important to be able to prepare for consequences, like by paying debts quickly, continuing to innovate, diversifying investments and boosting savings. If a country faces economic decline, then this affects consumer spending. If this declines significantly, then this may pose a financial risk to companies.
Legal risks may affect finances too. For example, unforeseen regulation changes and tax increases may have an impact on business functioning. If a company has to pay more taxes, then this could potentially affect how much money it is making.
Credit risk can be countered by requesting upfront payments for customers. If you extend credit to customers, this means that there is a chance of default. This would undoubtedly affect finances by having a direct effect on the revenues. With less money coming in, the company won’t be able to afford to pay overheads and to keep afloat generally.
Performance risk includes factors such as personal problems or even increased competition, which may affect company performance and eventually financial performance as a result.
The possible causes of financial risk vary quite a bit, but it’s always important to have a plan for how to prevent crises.