An essential element in the process of financial management for a corporation is identifying and controlling financial risks. This includes performing a risk analysis at least once a year to recognise and prevent potential future circumstances that could have a negative impact on your company’s profits.
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Financial risks are prospective occurrences that have the potential to result in a company losing money or adversely affecting its cash flow, which in turn has the potential to undermine the company’s capacity to pay its debts.
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All firms should be aware of the possibility of financial risk. Read on to identify the different types.
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Credit
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The most frequent risk that SMEs face is credit risk. Customers might not always pay on time, which can cause cash flow problems for firms.
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Unfortunately, bank loans don’t address the problem. SMEs may find it difficult to meet the credit standards of traditional financial institutions.
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Banks, for instance, would demand a lengthy track record of profitability. They may also request collateral in the form of real estate, equipment, or fixed deposits.
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Although owning or pledging such assets can pose a danger to liquidity. Businesses are therefore attempting to lessen one threat at the expense of another.
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Liquidity
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Cash that has been locked up in certain areas of the company puts it at risk for liquidity. The business is, therefore, unable to fulfil its short-term debt obligations.
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A straightforward example is a company with a high inventory of a certain product due to a significant forecast from a client. Due to the client’s default, the order is cancelled, costing the company the little sum of money it had stashed away in unsold inventory.
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The business must also pay its immediate debt at the same time. The only way to proceed is to sell the product at a significant loss-making discount.
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Before a decision is taken, the high cash-intensive business should be fully studied. Cash flow management needs to be purposeful and appropriate for businesses.
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It will avoid putting the business in the awkward situation of having problems repaying its short-term debt.
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The first step may be to keep an eye on the company’s liquidity. It is important to use and monitor tools like financial ratios that compare short-term assets against short-term liabilities.
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Operational
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Operational risk is concerned with potential dangers and hazards that may appear during business operations. It has to do with routine tasks and established procedures that enable a company to provide its goods or services. Operational risk varies across different industries.
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For instance, the manufacturing sector requires two machine maintenance, but the company can only afford one. Making the proper choice is essential to the company’s capacity to continue operating.
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The greatest danger can be seen as legal in another area, such as accidentally breaking copyright or trademark regulations. Defects in accounting and taxation are also thought to be operational risks.
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Businesses should be willing to seek the advice of outside specialists to reduce some operational risks. Lawyers, business secretaries, and financial consultants are just a few professionals who can help when dealing with rewards.
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Conclusion
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Financial risk cannot be totally eliminated from a business. These risks could eventually result in a corporation losing money and having a negative impact on cash flow.
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You can classify risks into different groups and define potential outcomes by first identifying the financial hazards that may exist. You can assess the importance of each risk and the possibility that it will materialise by analysing financial hazards.
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New Wave Accounting can provide you with a competent ,business accountant on the Gold Coast. We offer end-to-end accounting and reliable bookkeeping services that help grow your business. Book your appointment today to find out how our accountants can assist you!
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