Risk Assessment in Businesses – What, Why, When, and How?

Financial risk is the cash flow in the business when there is an unexpected financial loss. If the company cannot manage its debt payments, it will face financial difficulties. Firms with a higher level of debt face financial risk if they cannot make timely payments to their creditors.

Financial risk can be classified as follows:

• Credit risk occurs when a company extends a credit line to a customer and the customer fails to make payments. Similarly, creditors provide business credit, and the company defaults on the payment.
• Currency risk or exchange risk, occurs when the prices of the trading countries’ currencies fluctuate.
• Liquidity risk arises when a company cannot convert its assets into cash. This risk arises when a company requires a specific amount of cash to meet its short-term debt obligations.

Market risks are the potential losses that the company may face as a result of changes in market conditions. This assessment is important in risk management because it helps both investors and businesses identify potential threats to their financial stability and implement corrective measures to mitigate them.

The various types of market risks are mentioned below:

• Geopolitical risk arises as a result of changes in the political situations of the countries with which the company does business. It could be political unrest, unprecedented events, or natural disasters in the region. For example, the war in Ukraine causes imported goods to take longer to reach other locations, increasing their cost.
• Innovation risk arises as a result of technological changes. Customers are looking for alternatives as the market for the current item shrinks. Then, businesses must invest resources in constant research to introduce innovation to their products. For example, Nokia did not anticipate the emergence of smartphones and thus lost a large portion of the market to the iPhone.
• Competitors risk arises when businesses fail to analyze their competitors’ strengths and make changes to meet the needs and preferences of the time. For example, many American airlines are losing customers because they cannot compete with Middle Eastern airlines such as Emirates and Qatar Airways.
• Government policies risk arises when there are new policies related to the business are introduced and made mandatory for the denizens to adhere to. The policy change happens when a new government is formed or the present regime during the election year for getting a popularity boost. For E.g. the Sales tax replaced GST in India in 2017 made a huge impact on all businesses and citizens across the board.

There are hardly any industrial sectors where digitalization is not happening. With the rapid growth of online activities and payments, sensitive customer data is at risk. Customers expect that their data will be safe from any form of cyber theft. It has become mandatory for businesses to secure their cyberspace against any security breach or fraudulent activity.

When these incidents occur, consumer confidence and trust in companies can suffer. Not only do security breaches jeopardize a company’s reputation, but they can also leave the company financially liable for damages. E.g. Mydoom malware caused estimated damage of $38 billion in 2004.

Companies face legal risks if they violate government regulations like environmental regulations and the discharge of hazardous waste materials.

Employers must follow HSE (Health, Safety, and Environment) standards for their employees. If working in remote areas, they need proper working conditions, safety, and protective gear. Companies violating these laws are subject to various forms of punishment depending upon the type of damage.

Some risks are inherent to the nature of businesses. For example, infrastructure companies require large amounts of long-term funds -both debt and equity and timely availability is a significant risk. There can also be risks that are not linked to the nature of business, e.g., over-dependence on one vendor for a critical component in a manufacturing business. Managing the risks depends on this distinction as well as the availability of options to manage the risks. Accordingly, risks may be fully eliminated, their impact may be minimized or substituted, if substitution is possible, or they may have to be managed with appropriate organizational processes. Taking appropriate insurance covers, tweaking business processes to spread risks, having conservative financial policies, reviewing the organizational structure, and defining control processes for risk management, are some of the risk management techniques.

Companies find it challenging to assess business risks on their own for a variety of reasons. It is always best to delegate this problem to subject matter experts.

Astravise team has decades of experience running finance and operations in organizations of various sizes. We have also conducted risk assessment exercises as part of due diligence for our clients. We bring in external business expertise, where necessary to ensure clients get a comprehensive view of market, financial, legal, regulatory, operational, and cybersecurity risks.

We assist businesses in assessing their financial risks by analyzing financial statements and reviewing internal controls to detect any form of potential risk, such as fraud or accounting errors. Regularly, we analyze the company’s cash flow to identify liquidity risk and develop a strategy to stabilize the cash flow.

Along with financial controls, we thoroughly check our risk management strategy, scenario planning, and compliance monitoring to avoid any gaps in our assessment.