Financial Risk Management

What is financial risk management?

Financial risk management is the processing of identifying, analyzing, and quantifying the potential economic risks a company could face now or in the future. 

Any money moving in and out of a company has a certain amount of risk. Financial risk is the probability of financial loss from a business venture or investment. 

Businesses employ financial risk management to protect their financial assets and minimize credit, operational, foreign exchange, liquidity, reputational, and market risk. Financial risk management cannot get rid of risks, but it can equip companies with the tools they need to prepare for them. 

Companies use financial risk management software to manage their exposure to economic risks. Financial risk management tools allow businesses to conduct risk exposure analysis reports, create unique risk reports, and simulate different ways to react to those risks in the form of deals and investments. Some companies integrate financial research software to sort and analyze market data that will affect financial risk decisions in the future. 

Software de Financial Risk Management

Software que menciona a financial risk management como una característica o término.

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Types of financial risks

There are six major types of financial risks a company can face. While all can be predicted, some risks are more difficult than others to prepare for. 

1. Operational risk is the potential indirect or direct loss caused by a flaw in internal processes. These losses can result from day-to-day procedures, such as lawsuits, power outages, fraud, machinery failures, and more. 
2. Foreign exchange risk is caused by adverse exchange rate changes between two companies. These potential risks heavily affect companies that conduct frequent foreign business. Exchange rates can fluctuate at a moment's notice, so this risk is tough to predict and prepare for. 
3. Credit risk is the risk that a borrower will not pay back debts or outstanding payments. The borrower could be another entity a company has loaned money to or a company themselves as they borrow from others. A company that doesn’t balance its accounts payable cash flow risks losing valuable relationships.
4. Liquidity risk is the potential risks incurred when a company cannot comply with a sudden need for additional cash flow. These sudden needs can be caused by weather, political, or seasonal changes. Companies should ensure that they have available finances to adapt to these shifts and maintain operational efficiency. 
5. Reputation risk is the potential loss of social reputation, market standings, or financial capital resulting from negative events that damage a company’s reputation. This risk is the most difficult to prepare for because reputation is considered a goodwill intangible product asset and cannot be predicted. Employee boycotts, poor environmental sustainability practices, security breaches, and unethical conduct can cause companies to incur financial losses through bad press. 
6. Market risk is the risk associated with market changes. For example, the more customers prefer online shopping, the more the market changes to accommodate those preferences. Companies that don’t adapt to these market changes will lose potential customers to competitors and incur financial losses as a result. 

Benefits of financial risk management

There are many benefits to creating a successful financial risk management plan. These benefits outline how companies can utilize financial risk findings to their advantage. 

• Expect the unexpected. The goal of financial risk management is to prepare financial processes for any potential issues. Financial risk management analysis procedures can also help companies identify investment opportunities to improve their financial standings. 
• Gain a competitive advantage. Finding those investment opportunities can help companies get ahead of the competition by proactively adapting to market changes and financially preparing for them. 
• Avoid costly scenarios. When a company does not prepare for potential financial risks, there will be financial repercussions. 
• Prioritize financial growth. Companies that prepare for economic risks can use that data to make positive changes in the way they do financial planning. 

Financial risk management process

The financial risk management process begins with identifying what risks a company potentially faces and finding ways to mitigate them. At the end of the process, companies are ready to face these risks and equipped with backup plans to protect themselves financially. 

1. Identify potential risks. A company’s financial risks could be anything that has already negatively affected them in the past or anything they foresee as damaging in the future.
2. Examine the severity of the risk. To determine how much time and money should be spent on preparation, a company should identify how likely the risk is and how harmful the consequences could be. 
3. Prioritize the risks. Companies can use the findings from the last step to prioritize which risks need to be addressed first. By doing this, companies can ensure the most pressing issues are handled as soon as possible and resources are allocated effectively.
4. Consider different scenarios. At this stage, companies should look at the risk and create different strategies for adapting to and managing the financial risks. 
5. Choose potential solution plans. Once those scenarios have been analyzed, companies can choose exactly how they’d like to approach the risks. This includes whether it's worth it to even address the risk, how to avoid the risks, or how to face the risks head-on. 
6. Analyze results. Once the solutions have been implemented, companies should analyze how effectively the plan played out. These findings can finetune their plans to prepare for future financial risks. 
7. Continue managing financial risks. Financial risk management is never truly over. Even when a risk is not imminent, companies should continue creating plans for the future and keeping an eye on financial statements for potential areas of concern. 

Financial risk management best practices

There are a couple of best practices a company should keep in mind as they work through the financial management process. These best practices should aid in creating an efficient financial risk plan.

• Create a risk profile. Not all companies face the same risks. Companies should look at their internal processes to determine which risks they may incur. 
• Always have an emergency fund. No matter how strong a financial plan is, companies should ensure that they have money set aside in the case of an emergency.
• Monitor cash flow. A major element of financial planning is knowing exactly where company money is. This helps determine how much money companies have to prepare for financial emergencies.
• Automate the process. Wherever a company can avoid potential human error, it should. Software with artificial intelligence features can help ensure all information is as flawless as possible.