What Is Financial Risk?
Financial risk is any threat that hampers financial growth and a company’s profitability. All companies face financial risk from factors outside their control, from customers, suppliers, the economy, and legal regulations, for example. Risk exposure is a part of doing business, of course – companies take on risk because it invites opportunity for reward. New customers may mean more revenue, new suppliers may mean new product offerings, changing economic conditions may be in your favor, and new laws may make it easier for you to do business. Proper risk management ensures balance between risk and reward.
Top Financial Risks
Borrower’s risk – Also known as credit risk, borrower’s risk is the financial risk associated with too much debt, whether from bank loans, credit cards, or other sources. A business that is highly leveraged is operating on borrowed money, and too much risk could lead to ruin.
Economic risk – It’s important to understand the macro- and micro-economic risk that doing business in other countries may pose to your business. Dun & Bradstreet’s Country Insights Solutions provides a world map that ranks countries around the world according to geopolitical risk level, to help you identify risk and opportunity. Our quarterly Global Business Risk Report ranks the biggest threats to business to calculate an overall Global Business Impact (GBI) score.
Regulatory risk – Financial regulations, including Generally Accepted Accounting Principles (GAAP) standards such as ASC 606 and ASC 326, affect credit professionals because they cover how companies ensure they can collect credit and calculate their bad debt reserves.
Profitability risk – This type of risk involves managing cash flow to ensure the business can be run profitably. Companies that don’t depend on borrowed money still face risk if their operating expenses exceed revenue.
Third-party risk – Compliance professionals manage third-party risk to avoid being tainted by bribery and corruption issues. Consider these four steps to managing third-party risk to ensure you’re operating with integrity.
Other Types of Financial Risks Facing Businesses
Liquidity risk, asset-backed risk, and foreign investment risk also fall under the umbrella of financial concerns that can threaten a business’s bottom line. Here is a brief review of these financial risks:
- Liquidity risk affects a business’s ability to realize value from assets or access capital.
- Asset-backed risk refers to changes that might lower the value of a holding, such as a loan. A customer prepaying their debt falls into this category, as the lender wouldn’t earn as much interest as they expected.
- Foreign investment risk concerns changes brought about by the actions of a government. More aggressive taxation or political turmoil are examples.
How to Measure Financial Risk
Data and analytics are crucial to measuring financial risk. Businesses run on data, and they need to leverage their internal data and supplement with external data to understand risk exposure. Dun & Bradstreet’s study The (R)evolution of Risk Management found that the majority of finance leaders rely on analytics to inform risk management decisions.
Artificial intelligence (AI) and machine learning (ML) are gaining traction in helping companies make calculated risk decisions. AI and ML drive analytical decision-making with more speed and precision, and companies that use these automated technologies can achieve considerable gains. For example, AI-powered credit risk scores can provide predictive insight to help businesses decide which companies they should partner with, and which ones they should be more cautious about. Dun & Bradstreet’s analytics for risk management help companies measure, predict, and anticipate risk exposure.
As you can see, businesses face a variety of financial risks that can sap their earnings and stifle growth. Anticipating these risks – and taking steps to reduce your exposure – is an important part of a business’s overall growth strategy.
The articles above can help you learn about financial and credit risks and how data enables companies to more accurately assess the threat posed by other businesses.