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Financial Risk Assessment – Estimating the Risk Factors

Managing a business requires tools to help one make a financial risk assessment. It enables a manager to decide whether it is viable to extend credit or to gamble assets in the market.

Financial Risk AssessmentPHOTO BY FLICKR.COM/LUMAXART

Financial Risk Assessment - Making Calculated Guesses

Making a financial risk assessment requires the use of certain tools, such as audits and regular reviews, to make a calculated guess. These tools also signal how particular programs, activities and policies are affecting the financial stability of the business. In this way, corrective measures may be implemented in a timely manner. Several financial risk assessment tools may be used by a company to gauge the business’ condition when a particular move is decided upon. This includes knowing the current value of an asset and its expected returns over time. Its risks are forecasting what may eventually become a bad debt or the future value of a stock.

Financial Risk Analysis - Weighing Possibilities

In terms of extending credit, a financial risk analysis entails assessing whether a borrower has the capacity to pay the loan amount. Risk in this case is quantified through the interest added to the principal amount demanded by the creditor. If it’s too risky, a borrower can expect a higher interest. Financial risk analysis may be conducted through a balanced scorecard system. It measures credit risk by appraising the borrower’s credit quality, debt service ratio and if the current capital is sufficient to pay for the loan in a worst-case scenario. This allows companies to make choices that minimize losses and increase profitability.

Managing Financial Risk - Choices

Due to the different conditions surrounding borrowers and creditors, managing financial risk wisely is imperative. Over a period of time, interest rates may change or the value of the borrowed amount may rise or decline. Companies also face the risk of having liquidity problems. Because of these inherent risks, several strategies are employed to counter their effects and perhaps make the most of a favorable season. Given the inherent risks, the company sets limits as to how much risk it can take. From this, policies are formulated and implemented through derivatives and hedge funds to cushion any adverse impact on the business. Small companies may diversify or broaden its customer base or opt for refinancing of its loans.

Written by Simon Harris

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