When you are operating a business, it is obvious that at some point your business will face some risks. And you have to go for risk management in order to keep your business running. So, here I will discuss risk management along with financial risk management.
This will help you to stay prepared early so that you can overcome those risks and keep going with your business venture. So, let’s start with the definition of risk management.
- 1 What Is Risk management?
- 2 What Is Financial Risk?
- 3 What Is Financial Risk Management?
- 4 Who Manages Financial Risk?
- 5 FAQs
- 6 Takeaways
What Is Risk management?
In the world of finance, risk management is the specific process of identification, analysis, along with acceptance or mitigation of the uncertainty in all investment decisions.
At the time, when a fund manager or an investor analyzes and also takes the attempt of quantifying the potential for losses in an investment, like moral hazards.
After that, he or she takes the appropriate action on the basis of the investment objectives of the funds and risk tolerance. We are mostly aware of the fact that risk is inseparable from return.
There is some degree of risks involved in every investment. This risk is also considered close to zero only in the case of at-bill in the United States of America. The involved risk is very high when it comes to real estate or emerging-market equities in the high inflationary market.
Both in relative and absolute terms, one can evaluate the amount of risk. An investor who has a tough understanding of risk, along with its different forms, will be able to understand trade-offs, opportunities, and the involved cost better.
- The process of identification, analysis, along acceptance or mitigation of the uncertainty in all investment decisions, is called risk management.
- In the investment works, you can not separate risk from returns.
- There are various types of tactics present for ascertaining risk. Standard deviation is one of the most common ones. It is basically a statistical measure of the dispersion that is present around a central tendency.
- Beta, which is also known as market risks. And it is a measure of the volatility, or in other words, systematic risks, of an individual stock rather than the entire market.
- Now, the measure of excess return is known as alpha. Money managers, who implement active strategies for beating the market, are subject to this high alpha risk.
What Is Financial Risk?
Anything which is related to the money flowing in and out of any business is called a financial risk. The list of potential risks is really long, so most of the analysts consider them in the four categories. Here they are.
1. Market Risk
From the very name, we can assume what market risk is. The market risk is the risk, which comes out of the market where you are operating your business.
For example, in case you are running a clothing store, then the tendency of customers to shop online will be a marker risk for you.
Here, those businesses which start to adopt the online culture have a better survival chance than the businesses which stick to the offline business model.
It does not matter what the type is of your business sector, and every business is being operated with the risk of being outpaced by competitors. If you failed to keep up with the priming demands and consumer trends, then you may lose the market shares.
2. Credit Risk
The possibility of your money-losing as a result of failing to perform as per the contract’s terms. For example, with 30-day payment terms, you deliver products to a customer. But if the customer fails to make the payment on time, then you will suffer a credit risk.
So, every business has to retain sufficient cash, which is reserved in order to serve their account payable. Otherwise, the business will experience some serious cash flow problems.
3. Liquidity Risk
Have you heard about funding risks? Liquidity risk is the funding risk. When you are trying to sell assets or raising funds, you encounter some risks; those risks belong to the category of liquidity risk.
In the off-seasons, a seasoned business may witness a significant cash flow shortage. Have you put aside enough cash in order to meet the potential liquidity risk? How promptly will you be able to dispose of old assets or inventory for getting the cash you need for keeping the lights on?
Interest rate risk or currency risks also fall under the category of liquidity risk. If the interest rates of exchange rates suddenly change, what will happen to your cash flows.
4. Operational risk
During daily operations, a business may encounter other risks, apart from the above ones. Operational risks cover all of them. Inaccurate marketing plans, poor budgeting, unrealistic financial projections, lawsuits, fraud, theft, and staff turnover can invite risk, and that is too much to your bottom line without proper handling and careful anticipation.
What Is Financial Risk Management?
Financial risk management is particularly the process of understanding, along with managing the financial risk that your business is currently facing or will face in the future. It is not all about eliminating the risks.
Instead, it is more about drawing a line in the stand. The main idea is to understand what risk you need to avoid, what risk you are willing to take, and on the basis of your risk appetite, how you are going to develop a proper strategy.
Planning the action is the key to almost any financial risk management strategy. Your business will use policies, procedures, and practices for making sure that it is not taking any risk other than it is prepared for.
This plan will also allow your staff to get a clear idea about what they can not and can do, who has the overall responsibility for any kind of risk that may arise, what decision needs escalating.
Who Manages Financial Risk?
When it comes to small businesses, the senior managers and business owners have the responsibility of managing financial risks.
But with the growth of your business and you include several departments and activities, you may feel the need for a dedicated financial risk manager for managing risk. On behalf of the company, the person also recommends required actions.
The premium accreditation for Financial Risk Management professionals recognizes the Global Association of Risk Professionals. In order to receive the FRM certificate, candidates should have a two-year work experience.
In addition to this, the candidate also needs to pass a rigorous exam risk on specific subjects. They are.
- Investment management.
- Operational risk.
- Credit risk.
- Market risk.
My readers often ask me some questions, related to risk management. So when I am covering this topic, I thought of answering those questions. This will help you get a deep knowledge about this topic.
1. What Do You Mean By Risk Management?
Consider A process, which allows overall risk along with understanding individual risk events along with managing proactively as risk management. It also includes optimization of success by reducing threats along with maximizing outcomes and opportunities.
2. What Are The Three Types Of Risks?
Widely, we can classify risk into three types. And these types are
- Business Risk.
- Non-Business Risk.
- Financial Risk.
3. Why Is Risk management Important?
From the above discussion, the importance of risk management may be clear to you. In the future, a firm can not possibly define its objectives without risk management. The whole objective of risk management is making sure the company is only taking those risks, which will help it to achieve its primary objective and at the same time keeping all other risks under full control.
4. What Are The Five Steps In Risk Management Process?
Here are the five steps in the risk management process.
- Identification Risks.
- Assessment Risks.
- Mitigation Risks.
- Monitoring Risks.
- Reporting Risks.
This is all you need to know about risk management and financial risk management. If you still have any doubt, then do not hesitate to leave them in the comment section. I will try to come up with a solution as soon as possible.