Financial risk: what is it and how to reduce it in the company?

A market premise that is part of the reality of all operating companies is financial risk . From the moment of opening to the consolidation of the business, there are risks associated with various factors that can influence operational development if they are not taken into account.

Starting a business or investing in a project without mapping out financial risk can put your company in an unfavorable and difficult situation to exit.

In the 2023 edition of the PwC Global Risk Survey , 56% of business leaders said they were very confident in their risk management department's ability to develop a culture that is more aware of potential threats.

Can you say the same about your company?

Raising awareness among teams regarding the risks involved in each decision is a strategic measure to increase the chances of obtaining positive results.

In this article, we explain what it is, the main types, tools that help in the analysis and the importance of risk management in companies. Continue reading and learn more about the topic.

What is financial risk?

Financial risk is the probability that a company will suffer losses when investing its capital in a project or investment, or will not obtain the expected return.

Every business decision carries some sort of risk with it, which demands a certain amount of awareness for better weighing of pros and cons.

This way, one can decide with more safety, previously planning measures that will be taken against the financial risks in case some of the projected scenarios come to pass.

In general, the greater the possibility of return, the greater the risk involved in the proposal. The opposite is also true. Therefore, it is not about closing your business to opportunities, but rather about evaluating the risk-benefit involved and defining safety parameters.

In the list of financial risk, we have:

Use of third-party capital with high interest rates, generating the risk of rapid debt;

High rate of customer default;

Fluctuations in market interest and exchange rates, which may compromise the business's working capital .

To guide the analysis in each situation, it is essential to know what type of financial risk is at stake. See what they are in the next topic.

What are the main types of financial risks?

The main types of financial risks for a company are:

• Credit risk;
  
• Liquidity risk;
• Market risk;
• Operating risks;
• Information security risks.

Understand the factors involved in each type and why they generate financial risks:

1. Credit risk

Credit is a financial risk that is related to the default rate of a company's customers . Companies that work with installment payments have this threat heightened.

Therefore, credit analysis is an essential procedure for the sales team to approve a payment method, for example. If the risk with a customer is high, the proposal may include safer options.

As risk is a factor that cannot be completely eliminated, it is important for the company to have preventive measures to deal with default and define limits so that the operation is not affected.

2. Liquidity risk

Liquidity involves the capability of liquidating assets into cash within a short period. The financial management team analyzes the various levels of current liabilities and assets that would, in turn, provide the measure of liquidity existing.

Current liabilities are short-term debts (up to one year) and current assets are inputs that can be quickly transformed into cash to pay outstanding bills.

To avoid financial liquidity risk, it is necessary to assess the amount of fixed assets in relation to the amount of available resources. This makes it possible to safely control expenses if liquidity is low.

3. Market risk

The market is also a type of financial risk. This is because factors such as the price of inputs, financial assets, among others, are quite volatile, in accordance with the principle of the law of supply and demand.

Each market niche is impacted by specific circumstances. Therefore, companies need to assess the existing conditions and draw up a plan to absorb price increases, for example, and, if necessary, reduce profit margins.

According to the survey by consultancy firm PwC , 68% of the leaders interviewed are increasing spending to add technology and digital resources to the risk management team and 50% are complementing investments with changes to the staff and processes.

4. Operating risk

The operation is an internal financial risk factor because failures in production systems and human errors can generate a cascade effect, influencing planned sales objectives.

Therefore, all risks can be mitigated in processes, such as preventive maintenance, rest breaks, inventory management , automation of internal processes, preventing orders from being delayed in delivery, displeasing customers.

5. Information security risks

The digitalization of business processes generates risks related to the security of information stored in digital systems, in the cloud or in internal systems.

The leaking of this information is a financial risk, as confidential data may be leaked, making projects unfeasible that the company was betting would achieve a good return.

In this case, it is essential that companies reinforce cybersecurity solutions, protecting machines and educating staff on digital security practices.

How to minimize problems with financial risk management?

There is no escaping financial risks, but it is possible to mitigate them by establishing robust processes that ensure that each decision is made taking into account all the factors involved. Some key actions that the responsible team should follow are:

Carry out risk mapping: by knowing the factors that impact each decision, the team can better control threats;

Create scenario models: with models it is possible to weigh up the advantages and disadvantages of taking certain risks;

Follow the financial plan: the plan establishes safe margins to prevent the company from making a loss, so prepare and follow the guidelines;

Monitor financial results: periodically analyze company finances to assess whether the business is managing to overcome risks and grow.