Finance Risk Management
Types of financial risk
Risk management strategies depend on the type of financial risk the organisation faces. There are four types of financial risks.
Operational risk is the risk of revenue loss due to failed or impaired business operations. This could stem from a variety of problems, such as lawsuits, fraud, natural disasters, or process inefficiencies. Operational risk can be minimised by adequate insurance, regular system maintenance, and weighing costs against benefits while planning future spend.
Market risk stems from a change in the marketplace where the business operates. For instance, increasing competition or online shopping trends pose a market risk to garment manufacturing companies. Some ways to manage market risk are reducing profit margins, improving the value proposition, and diversification.
Liquidity risk arises if a company cannot generate enough funds for operations or debt repayment. It can be mitigated by regularly assessing cash flow and collateral needs, optimising working capital, and managing credit facilities.
Credit risk is defined as the possibility when a company incurs a loss if its vendors or suppliers default on payment. Credit risk management must consider not only the principal amount but also factor in interest loss and mounting collection costs.
Finance risk management strategies
Risk management is crucial in maintaining the financial health and credibility of an organisation. Most financial risk management strategies fall into one of four categories.
Businesses can make an informed decision to accept a risk if there are low chances of occurring, is perceived as low impact, or if the risk management costs exceed the perceived damages.
Businesses reduce risk by taking advance measures to minimise future problems. Examples of risk reduction are investing in system maintenance and updates and implementing digital solutions for workflow automation.
Risk avoidance is avoiding any action that can increase the probability of the risk manifesting. Avoidance is the best strategy when the perceived damages due to the risk are high. Some examples of risk avoidance are avoiding low-quality production tools or not trading with companies with low credit scores.
Companies mitigate their risk by transferring it to an external party in exchange for payment. Insurance and outsourcing work to contractors are the best examples of risk transference.