Are you a businessman or businesswoman? Or if you are a student, an office worker, do you hope to become a successful businessman in the future? Very well then, this article is precisely share with you on how to handle Financial Risk in any business.
Table of Contents
What is Finance Risk?
Finance is a term used to describe the process of providing funds for the business activities including making purchases, or investing. In a simple word, finance is about management of money. It is the lifeblood of all the business in the sense that it is needed for establishment, continuity as well as expansion of a business. Without the proper management and adequate sourcing of finance, the business may undergo a liquidation.
Risk simply means relative uncertainty or the state at which the outcome of an event may deviate from what is expected. Risk is different from uncertainty because it has some level of predictability as opposed to uncertainty.
Financial risk comes into play during decision making and management of opportunity costs attached to every decision we make. It is a type of danger that it will result in losing capital on an investment or business venture. The common financial risks include credit risk, liquidity risk, and operational risk.
Most of the times, businessmen neglect opportunities and chances for expansion due to fear of risk. In fact, when there is a risk does not mean they are unachievable. It only means that we have to work harder to achieve them. Beside every decision we take lies a risk itself.
Handle Financial Risk by making decision
The truth is that risk can be measured and managed. Hence, there is no need to be stagnant in business without consideration of innovation and movement with trend. Of course, technology and services of today can be less useful with time if no values are added. We could start by taking a risk on 10% of our earnings on expansion and improvement of services and see the effects on the next year’s total earning. The risk is more manageable than a risk taken on miscellaneous funds for investment in some of the promising companies in the country. People would say that it’s quite risky to invest because we could lose such money. That is okay for a pessimist. It’s good we consider all possibilities within the parameter rather than being one-sided. Losing the money is not the only thing that can happen; the money could also double up with time, while on the other hand, if that money is spent materially or kept at home there would be no chance of doubling its value.
Basically, a corporate organisation is faced with four decisions on which their risk lies.
It is the decision on the capital structure of the firm. It deals with the decision on what amount of debt and equity would be combined to run the organisation. The finance manager carries out the finance decision. He carefully considers the interest on various debts he is sourcing and the control of the firm in the case of the sales of equity.
This is capital budgeting decision. It must be carefully handled to prevent the firm from ending up with nothing on its investment. It is one of the riskiest decisions.
This is the decision on the proportion of profit to be distributed as dividend. It should be handled well to encourage prospective investors to patronize the organization.
This decision needs proper handling to save the firm from the risk of illiquidity. This is the decision on the proportion of cash for financing current assets. This is quite risky because it goes a long way to affect the profitability and continuity of the firm.
The levels of risk perceptions
Generally, it is often believed that individuals vary with their levels of risk perceptions. Some are risk lovers, risk averter and risk neutral or avoider. Please my wonderful readers don’t be deceived into believing that you are strictly in one of these classes. You can exhibit all of them based on circumstances before you; you can be automatic because I and many other financial experts have been so.
The fact that you read “Financial Risk and you” does not mean that you should indulge in a business opportunity with high risk without considering their returns. Off course, the risk lovers can be so intoxicated to fall a victim of this. It is paramount that the first thing you think about before taking a risk is the return. The magnitude of the return expected should be the drive for your taking a risk.
When you come across an opportunity that would never earn up to your expected return ever in your widest imagination, you automatically become a risk neutral. Don’t take a risk on such opportunity. Risk averter on the other hand has to do with efficient management of risk.
Handle Financial Risk by diversification
A straightforward answer is that, we can manage risk through risk diversification or spreading them on different investments. These kinds of investments are generally called portfolio investments. It is quite obvious today that too many of us put the whole of fund in one company hoping that such company would remain the best among others forever. This is like “putting all your eggs in one basket” and all eggs go down with the fall of such basket.
A little illustration would be paramount to clarify our understanding. Take for instance: A boy wants to invest 50% of his entire savings. Rather than putting all in ABC Sunglass Ltd, he puts half in DEF Umbrella Ltd and the other half on ABC Sunglass Ltd. In the raining season he gets more dividend from DEF umbrella Ltd because they sell more while in the dry season that is sunny, he gets more dividend from ABC Sunglass Ltd. He manages his risks on investment because his investment in ABC Sunglass Ltd would compensate for the losses in DEF Umbrella Ltd during the dry seasons.
Note! As a business tycoon, politician, trader or even as a student, you could spread your funds in more than three investments so as to have efficient management of risk.
In conclusion, I believe that money, finance and risk are three things that we cannot escape in the business journey. A proper knowledge of the fusion and management is needed to becoming a financial giant that we aspire. Hence, it is the candid opinion of this article that you carefully and systematically go through the article and hook up to many detailed secretes that could tremendously trigger your financial breakthrough even in the presence of a very risky business environment.