What is Financial Risk? Definition and Example

What is financial risk?

Financial risk is a possible risk that a company won’t be able to pay back all the money that it owes its creditors. Thereof, investors will lose their invested money. The bigger debt the company has, the higher the potential financial risk of not meeting the obligations.

Any person, who is into investing and trading, should be aware of risks that can occur. It’s something, that companies are exposed to. The consequences of financial risks associated with the financial results of the company are not only financial losses, but also the bankruptcy of the business.

Potential financial rick should be taken into account at the moment of deciding whether to invest in the certain business or not. There are several tools available to determine how risky investing in the particular company is:

Fundamental analysis is the way to calculate the value of the company by analyzing all aspects in general, such as its earnings, assets etc.

Technical analysis is the analysis of the company’s share prices and trading volumes.

Quantitative analysis is the way of defining certain risks using mathematics and statistics.

What types of financial risks exist?

Credit risk

A counterparty is unable to repay its debts

Liquidity risk

Company’s money flow is poor

Currency risk

Company is influenced by currency changes

Foreign investment risk

Overseas assets can be in danger

Asset risk

The value of the company’s asset can fall

Various types of risks can have different impact on the company in question. So, if it’s impossible to remove the risk completely, it can at least minimize it.

Financial risk analysis is a part of the analysis of the companies’ financial situations, whose actions a person wants to trade. The more stable a company's finances, the more likely that its shares will increase in price in the long run.

Financial risk VS Business risk

Both financial risk and business risk are key factors in making investments, however financial risk is about company’s ability to manage its leverage and debt, whereas business risk is about company’s ability to obtain enough profit to cover its operational expenses.

In other words, financial risk is how company deals with necessary payments, and business risk is how the enterprise functionate as a profitable organization.

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2022-12-07 • Updated

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