Trading Toolkits

Trading ToolKits: Financial Risk Explained

There exist some elements of risk involved in any related financial ventures; trading or investing. Without risk management, losses are inevitable and financial growth would be stunted.

What is Financial Risk?

Financial risk is the risk of losing money or any valuable assets; it’s a potential amount of money anyone can lose in a particular business, trade, or venture. It is not the loss itself but the potential for loss. The concept is applied to a broad range of applications, including management, business administration, trade, exchange services, and government. Getting familiar with the different financial risk types and adopting strategies to manage such risks is known as risk management.

Financial risk occurs in financial markets due to macroeconomics force in action, changes to the market interest rate, and the possibility of default by sectors or large corporations. Individuals may also face financial risk when they engage in economic activities that could jeopardize their income.

Types of Financial Risks

There are four types of financial risks common:

  • Operational Risk: Deals with employee fraud, retention issues, and flawed business models. This type of risk is specific to companies rather than the overall market and could result in higher costs, lower production, and other ROI issues.
  • Credit Risk: The chances that a business won’t pay its debt is better known as credit risk. Higher credit risk for business is the higher interest rate for an applied loan. A default makes it higher and more difficult for companies to access loans.
  • Market Risk: Simply means the more dynamic the market condition is, the more its potential for loss.
  • Liquidity Risk: How quickly a business can turn its assets into cash is determined by its liquidity risk. If a company can not pay off its short-term debt with its asset, it has a high liquidity risk.

Strategies to Manage Financial Risk

The proper financial risk management will determine a lot about the growth and success of a business. Without which imminent death and redundancies over the long term are expected.

  • Capital: Where your capital comes from is as important as the business or start-up. Relational capital, a type of capital mostly utilized, is one of the essential capital types. In relational capital, a player leverages their relationship to maximize their benefits. It is beneficial between both parties and does not mean exploitative or manipulative.
  • Financial Statement: Learning to read financial statements will save you many personal and business economic issues. You can employ an expert’s service if you can’t find the time nor have the necessary expertise to do this. However, doing it yourself is a skill needed for anyone looking at taking control of their finance. As Keith Cunningham, a businessman, author, and financial expert, puts it: “If you can’t read the scoreboard, you don’t know the score.”

Why is Financial Risk Significant?

Financial risk in itself is not inherently good or bad. However, the term “risk” may connote negativity to a term in its usage. It is present no matter its application as risk can spread from one business to affect an entire sector or the entire world. For example, the coronavirus pandemic affected the world’s entire economy at the start of the previous year.

Understanding of financial risk can help individual or business make;

  • Informed financial decisions
  • Credible assets valuation 

Understanding Financial Risk

The strength that comes with the knowledge of a specific financial risk comes from its management. The proper knowledge about a potential threat and risk due to analysis will help individuals or businesses better prepare and understand their assets. Chances for failure are reduced with this knowledge.

What is the Threat?

Not understanding and applying financial risk management in the early stage of a business will result in the following cons associated with lack of knowledge or application:

  • Losses resulting from uncontrolled and unpredicted outside forces.
  • Losses will be difficult to overcome
  • Ability to spread and affect the entire market or sector

Concluding Thoughts

Chances of failure of a business or getting into personal financial woes are reduced significantly when an individual or company understands the fundamental financial risk associated with their business or decision.

Being deliberately unwilling to take responsibility and the discipline could become catastrophic in the long term. Financial risk knowledge can be applied in any sector, i.e., personal business, trading, investment, etc.

Create a financial risk management plan today!

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