Everything You Need to Know About Financial Risk Management

A good financial risk management plan can save your business from financial debacles. For any growing business, it’s essential to address financial risks that impact the cash flow cycle. If you can anticipate risks well in advance, you save yourself from experiencing a cash crunch and other financial problems. 

In this blog, we’ll discuss the categories of financial risk and why it is important to develop a solid risk management plan and place stern measures in order. Let’s begin.

What is Financial Risk Management?

Financial risk management is a practice that a businessman can follow undertaking several financial instruments and data analysis aspects to manage inflation, liquidity, credit, market, foreign exchange, and other types of risks. It helps you identify the risk sources so that you can measure them well and develop plans to reduce their effect. 

In any retail space or banking sector, financial risk management practices are common. However, its need is not just limited to banking, but all businesses must consider it as the need of the hour. From asset management firms to consulting companies, every business should be well versed in understanding the crux that would lead to better financial planning.

Types of Risks

Credit Risk

If your business loses money or fails to maintain a balanced cash flow cycle, it’s a credit risk. In a business, it can so happen that you lose money if your suppliers or vendors fail to follow the contract’s guidelines. They could face a financial crunch, and if your money is stuck or you’re the creditor here, it’s a tough call. For example, if a customer forgets to share the invoice on time or delays payments, your business is obliged to go through the credit risk. That’s why businessmen should pay heed to retain sufficient cash reserves to handle the business well in case of emergencies.

On the other hand, you can reduce the credit risk by approaching credit information bureaus like CreditQ where you can report your business credit defaulters on the platform and get help in payment settlement. 

Market Risk

As the name suggests, a market risk includes the changing dynamics of the market and how it affects your business. If your business mainly runs on an online mode and your customers prefer shopping online, there’s a better chance that you can satisfy the online crowd through innovative strategies compared to the offline business model, which could be riskier. To sum it up, if you fail to keep up with the consumer trends and meet the pricing demands, you’re likely to lose market shares. 

Operational Risk

Any risk that your business may encounter, such as fraud, theft, staff turnover, or poor budgeting, falls under the operational risk. When you’ve not anticipated your risks and set unrealistic financial projections, and spend more than required, it’s not good for your business. 

Financial risk management is all about understanding and managing the financial risks that may impact your business today or shortly. 

Liquidity Risk

If you’re trying to raise funds for business expansion or selling assets, it’s a liquidity risk. In a layman’s language, if you’re finding it hard to raise cash faster than expected, your business experiences liquidity risk. A seasonal business may enjoy seamless sales growth during a certain period, but what about the off-season. Does your business have enough cash to buy new assets or purchase inventory? Liquidity risk is also connected to the interest rate risk. Have you ever thought about what would happen to the cash flow cycle if the interest rates or exchange rates suddenly fluctuate?

To overcome such challenges, you need a solid financial risk management plan. It starts with budgeting your finances well enough to survive in extreme cases. 

How do you implement a smart financial risk management plan?

To begin with, you should reduce cash flow volatility. If you ignore it, you may find yourself juggling through several months where you need cash but don’t have enough measures to get the cash in. Another good step you can take is to manage your operating costs and put solid credit control measures in place. 

To play safe and minimize business risks, you can either manage your payment terms with the vendor or find a possibility to close business with payment defaulters who are abusing your credit terms. Reporting your business credit defaulters on relevant credit reporting companies can help you get your stuck money back if you wish to continue business with them.

The next best thing you can do is to understand the risks in a partnership or joint venture. When you duly analyze the risk factors and perform due diligence on the projects undertaken, you save yourself some time and money. If you’re a small business owner, you should ensure that you’re hiring the right people for the jobs to increase productivity and reduce the risk of fraud.