Two Important Risks Every Business Owner Should Understand
The two primary risks that every company has to face on a daily basis are business risk and financial risk, and contrary to common belief, they are not one in the same. Understanding these two types of risk is critical for keeping your company profitable and manageable, especially during times of economic uncertainty.
Knowing the difference between financial risk and business risk is also important when it comes to speaking with investors, financial institutions, and other people or organizations that may have a financial interest in your company.
What Is Business Risk?
Business risk usually involves all of the risks attributed to the business’s strategic decisions, with the exception of the company’s financial decisions. Such risks could include the decision to introduce a new product or service into the market, or a potential partnership with another company. In estimations of business risk, internal efficiency and production quotas are commonly measured to determine whether or not a key business decision is worth the risk.
What Is Financial Risk?
A company’s financial risk is predominantly targeted at its shareholders and those who own or buy the company’s stocks as this type of risk is based on how a company’s finances are structured, and traditionally focuses on corporate debt. Companies that rely heavily on business financing are often considered risky.
What Affects a Company’s Business Risk?
There are several factors that can affect the business risk level of a company. The fluctuations in demand for a certain product or service can certainly affect business risk as this will have a direct impact on a company’s profits. In addition, every time a competing company introduces a similar product to the market, it has the potential to drive down costs and sales, both of which can affect a company’s earnings. Changes in business risk can also be attributed to external factors like government actions and changes in consumer preferences as well as internal factors like the company’s ratio of fixed to variable expenditures.
What Affects a Company’s Financial Risk?
One of the most common things that can affect a company’s financial risk is the quality of the financial system within its country of operation. If a company is based in a country that has a poorly functioning financial system or devalued currency, its financial risk will usually be relatively high as the company’s holdings could easily be eliminated. For most American-based companies, however, their financial leverage is usually used to determine their risk level. Financial leverage is a company’s debt to equity ratio. The more a company relies on debt to finance the business, the higher their financial leverage is and therefore, the company is a higher financial risk.