The nature of financial risk lies in the uncertainty and unpredictability, when even a small change in cash flow, interest rates or financial obligations can lead to major consequences for the business. To survive and develop, risk control is not only a management task but also a vital factor.
This article by Bizzi will analyze in detail the nature of financial risks, their classification and the most effective ways to prevent financial risks.
What is Financial Risk? Definition and Impact of Financial Risk
Financial risk is one of the major challenges that every business faces. Understanding the definition and impact of financial risk helps managers assess financial health and plan management more effectively.
What is Financial Risk?
Before going into details, it is important to understand the nature of financial risk. It is not just the numbers on the report but the possibility of a business losing capital, profits or solvency due to financial fluctuations.
Financial risk is the possibility that a business or individual will not be able to fully meet its financial obligations, resulting in capital loss, reduced profits or insolvency.
- For businesses: risks often come from debt, interest rate fluctuations, exchange rates, beyond capacity. business cash flow management.
- For investors: financial risks arise when investment value decreases or when the issuing company is unable to pay dividends and interest.
The main difference between financial risk and business risk
| Criteria | Financial risk | Business risks |
| Source | Due to capital structure (debt ratio) | Due to business operations and market environment |
| Scope of influence | Impact on solvency, financial pressure | Impact on operating profits |
| Level of control | Can be managed with financial strategy, debt optimization | More difficult to control because of the impact of external markets |
| For example | Businesses borrow too much, leading to inability to repay debts. | Sales plummeted due to changing customer tastes |
What is the impact of Financial Risk?
It can be said that financial risk is not only the "risk of losing money", but also directly affects the survival of the business, the interests of investors and the stability of the economy.
- For business
- Increased cost of capital: Interest, bond issuance costs, and opportunity costs are all higher.
- Insolvency: When cash flow is not enough to pay short-term debts → risk of bankruptcy.
- Reduced reputation and capital mobilization opportunities: Partners and banks are more cautious when granting credit.
- For investors
- Reduced expected returns: Due to fluctuations in stock or bond prices or the risk of corporate default.
- Increased volatility: Financial risk often entails market risk and investment risk.
- For the economy
- If many businesses fall into financial risk, it will lead to a credit crisis and destabilize the financial system.
Financial Risk Classification – Common and In-depth Risk Types
Financial risk is not simply a number of losses but comes from many different sources. Understanding and classifying financial risks helps businesses build prevention strategies, diversify risks and make more accurate investment and borrowing decisions.
Market Risk
Market risk arises from fluctuations in the financial market, directly affecting the value of assets and investment portfolios of enterprises. Early identification of these fluctuations helps enterprises minimize unexpected losses.
- Risk of loss due to fluctuations in financial values in the market (stock prices, bonds, commodities, exchange rates).
For example: Exporting enterprises are at risk when the USD depreciates against the VND.
Credit Risk
Credit risk arises when counterparties fail to meet their financial obligations. This is a particular threat to the management of receivables and payables, and can have a serious impact on a company's short-term cash flow.
- DThe partner failed to fulfill his payment obligations on time.
- Related to:
- Accounts Receivable (Accounts Receivable – AR): Risk of customers paying late or not paying.
- Accounts Payable (AP): Risk of business losing reputation, being fined or losing discounts due to late payment.
For example: Customer bankruptcy makes the business unable to collect debt.
Liquidity Risk
Liquidity risk occurs when a business does not have enough cash to meet its short-term obligations, even though its total assets still have value. This is the main cause of bankruptcy risk, even when the business is profitable on paper.
- Lack of cash or the ability to convert assets into cash quickly.
- Affects short-term solvency and ability to maintain daily operations.
For example: A company has a lot of inventory but cannot sell it to pay interest on loans on time.
Interest Rate Risk
Fluctuations in market interest rates can increase borrowing costs and affect financial returns. This risk is particularly important for businesses that use large amounts of debt.
- Changes in borrowing costs impact net income.
- Causes fluctuations in cash flow and financial plan long term
- Bank loan interest rates increased suddenly, causing financial costs to exceed estimates.
Legal Risk & Systemic Risk
These risks are less talked about but can have a major impact on a business. Legal Risk relates to compliance with laws and contracts, while Systemic Risk arises from failures in the financial system or economy.
- Legal Risk: Enterprises violate or do not comply with financial, accounting, and tax regulations → incur fines or lawsuits.
- Systemic Risk: When a large financial institution or a market fails, it can spread to cause a crisis throughout the entire system (e.g., the 2008 financial crisis).
Other Risks
In addition to the main risks, businesses also face other types of risks such as investment risks or financial leverage risks. Full identification helps businesses to plan effectively and manage their finances comprehensively.
- Investment Risk: The investment does not yield the expected returns.
- Financial Leverage Risk: Businesses use too much debt, leading to too much pressure to pay interest and principal.
- Exchange Rate Risk: Foreign currency fluctuations affect import and export activities.
What causes businesses to face financial risks?
Financial risks often come from both internal factors (capital management, cash flow, accounting) and external factors (macroeconomic, legal, partners). Understanding the causes helps businesses identify risks and prepare appropriate preventive measures.
Causes from macroeconomic fluctuations
This is a group of factors that are difficult for businesses to control but have a strong impact:
- High inflation: Increases input costs (raw materials, labor), while currency value decreases → businesses find it difficult to balance costs and revenue.
- Economic crisis: Consumer demand decreases, customer cash flow is tightened → debt collection ability decreases → easy to lose the ability to pay off loans.
- Monetary policy: When interest rates increase, the cost of borrowing increases; when exchange rates fluctuate, businesses borrowing foreign currency or importing are susceptible to exchange rate risks.
Causes from internal financial management
This is a group of factors caused by the business itself, which can be prevented if well managed:
- Poor governance: No financial planning, no clear capital strategy leads to inefficient use of capital.
- Financial leverage abuse: Businesses borrow too much compared to equity (D/E too high) to expand rapidly → debt repayment pressure increases sharply when revenue does not meet expectations.
- Lack of cash flow control: Not closely monitoring cash inflows and outflows, not forecasting cash flow, leading to short-term loss of liquidity.
What is the effective solution in Financial Risk Management & Prevention?
Finding a comprehensive and effective financial risk management solution is not just an option, but a mandatory factor to protect financial security; build reputation and trust, and maintain a sustainable competitive advantage in a volatile business environment.
Building a systematic risk management system
Enterprises need to establish a clear risk management framework, decentralize responsibilities, and combine the use of in-depth financial analysis indicators:
- Debt to Equity Ratio (D/E Ratio): Measures the degree of financial leverage.
- Current Ratio: Ability to pay short-term debts with current assets.
- Quick Ratio: Checks the ability to pay immediately without depending on inventory.
Strengthen control of cash flow and liquidity
Stable cash flow is the foundation of every business, helping to reduce the risk of liquidity shortage.
- Manage cash flow closely: Track daily income and expenses.
- Build a contingency fund: Helps businesses maintain operations in crisis situations.
- Diversify capital sources: Combine short-term and long-term loans, issue bonds or call for investment to reduce financial pressure.
Market and interest rate risk hedging
Market and interest rate fluctuations can directly affect the cost of capital and returns.
- Monitor macro fluctuations: Exchange rates, interest rates, raw material prices.
- Hedging tools application: Forward contracts, futures contracts, interest rate swaps to limit adverse fluctuations.
Apply Financial Automation Technology with Bizzi
Financial risk is essentially the uncertainty in cash flows and financial obligations, where even a small fluctuation in the market, interest rates or internal cash flow can create a chain reaction to the entire business operations. This puts businesses at risk of capital imbalance, reduced profits and even insolvency. In that context, technology plays a key role as a "shield" to help businesses forecast, monitor and respond promptly to risks.
Bizzi helps businesses manage risk by automating financial processes such as spending, debt collection and invoice management, thereby minimizing manual errors, tightly controlling cash flow, ensuring policy compliance and increasing financial transparency. With automation solutions, businesses can identify potential problems early, issue timely warnings and provide visual data for decision making, helping to prevent risks effectively.
Cost and budget control:
- Set up smart spending policies: Bizzi allows you to set up and customize expense policies, ensuring all expenses comply with regulations, minimizing the risk of loss and error.
- Automated approval process: Automating the expense creation and approval process reduces processing time, increases transparency, and reduces errors.
- Detailed budgeting: Support budgeting for each department and project, helping to control financial resources well.
Effective debt management and collection:
- Automatic debt reminder: Send automated emails and messages to remind customers of payment due dates, minimizing overdue debt and the risk of debt non-recovery.
- Closely monitor debt: Track receivables by invoice, contract and customer, providing metrics like DSO (Days Sales Outstanding) and debt aging reports to stay on top of the situation.
- Automatic reconciliation: Helps reconcile customer debt balances and bank statement transactions, ensuring accuracy.
Automate invoice processing:
- AI Bot Assistant: Automatically receive, store and reconcile input invoices, minimizing manual work for the accounting department.
- Minimize errors: Automation eliminates human errors in invoice processing, avoiding major risks arising from small mistakes.
Enhance transparency and decision-making:
- Visual reporting: Provide detailed dashboards and reports on cost, budget and debt situations, helping managers have a comprehensive view and make quick and timely decisions.
- Real-time tracking: Allows real-time monitoring of financial status, helping businesses proactively adjust plans and respond flexibly to market fluctuations.
Practical application: Financial risk in each context
In different contexts, what forms will financial risks take?
Financial risks in business
Businesses face many types of financial risks as mentioned:
- Liquidity risk: Not enough cash flow to pay short-term debts, for example, a manufacturing company has large revenue but customers have capital occupied → lack of money to pay salaries and suppliers.
- Interest rate and exchange rate risksEnterprises borrow USD to import, but the exchange rate increases sharply → financial costs increase.
- Risk of excessive debt:Using high leverage during economic downturns can lead to bankruptcy.
Typical: During the COVID-19 period, many tourism and aviation businesses had to take out short-term loans to maintain operations, but demand dropped → unable to repay the debt.
Personal financial risks and stock investment
Expanding to the personal and investor context:
- Personal risk:
- Consumer credit debt (home loans, car loans, credit cards) exceeds income.
- Loss of primary source of income (job loss, illness) leading to inability to repay debt.
- Risks of stock investment:
- Market volatility: Stock prices fell sharply due to macro news, industry crisis.
- Liquidity risk: Cannot sell stocks when the market is not active.
- Margin leverageInvestors use borrowed money to buy stocks, when the market falls → margin call, heavy loss.
For example, in 2022, when the Fed continuously raised interest rates, the global stock market plummeted, and many individual investors using margin had to sell off.
Financial risks in banking and real estate market
These are the areas of systemic financial risk:
- Bank:
- Credit risk: Borrowers cannot repay their debts.
- Liquidity risk:The bank does not have enough money to pay for the bank run.
- Interest rate risk: Fixed interest rate loan but capital mobilization costs increase.
- Real estate:
- Loan risk: Real estate businesses borrow a lot to develop projects, when the market freezes → cannot sell products → bad debt increases.
- Legal risks: The project was not fully approved, causing financial loss.
- Market risk:The real estate recession cycle causes prices to fall sharply and inventories to increase.
- Loan risk: Real estate businesses borrow a lot to develop projects, when the market freezes → cannot sell products → bad debt increases.
Typical: The 2008 US real estate crisis originated from subprime banking and the housing bubble, leading to the global financial crisis.
Frequently asked questions about what is financial risk?
Below are answers to frequently asked questions regarding financial risks:
When does financial risk arise?
Financial risks often arise when businesses or individuals use borrowed capital, depend on unstable cash flows, or are affected by macroeconomic fluctuations (interest rates, exchange rates, inflation). For example: a company borrows a large amount of money to expand production while revenue is uncertain → there is a risk of insolvency.
Can financial risk be measured?
Yes. Financial risk can be measured through financial indicators:
- Debt to Equity Ratio (D/E): Shows the degree of leverage.
- Debt Ratio: Shows the proportion of debt in total assets.
- Interest Coverage Ratio: Assesses the ability to pay interest.
These indicators help predict the level of risk and the ability of a business (or individual) to withstand financial fluctuations.
Conclude
Hopefully with the above information, readers will have a clearer perspective on the nature of financial risks. In the context of unpredictable market fluctuations, financial risk control is not only a "shield" to protect businesses from unexpected losses but also the foundation to maintain stability and sustainable growth.
However, with the huge amount of data and the increasing demand for transparency, manual management is prone to errors, lack of control and slow response to risks. Therefore, applying financial risk management technology has become an inevitable trend.
Solution from Bizzi.vn – with the ability to automate invoice processing, expense management and debt control. Digital financial management solutions like Bizzi.vn not only automate data processing, debt and expense control, but also provide real-time reporting, helping businesses proactively grasp risks and turn them into opportunities to optimize operational efficiency.
Register here to receive advice on solutions suitable for your business: https://bizzi.vn/dat-lich-demo/