HOW TO MANNAGE FINANCIAL RISK

Objective of the E- BOOK 

  • To minimise the financial risk

Key Learnings from the Video

1. What is financial risk?

When a company or an individual fails to meet financial obligations, it is known as “Financial risk.”

For example:

  • An individual raises a personal loan from the bank and fails to repay the loan.
  • This is a financial risk.

2. Impact of financial risk

The impact of financial risk on the following 5 stakeholders is as follows:

  • Companies: Companies face debt due to financial risk.
  • Investors: Investors face loss of invested capital in the companies such as DHFL, Gitanjali, and Jet Airways, etc. In all these companies, investors lost their money because these companies failed to repay their loan amount.
  • Individuals: When an individual fails to pay a loan amount that is more than his income, he will face losses.
  • Government: When a government borrows money from IMF and World Bank and it fails to repay the loan, the government defaults.
  • Financial markets: It involves macroeconomic risks based on:
  • Market interest rate
  • Change in sector
  • The raw materials price hike

3. Financial risk factors

  • Capital funding: When you go for capital funding, your business gets exposed. If you are an investor and the borrower defaults on a loan, you will lose your money.
  • Ensuring loan repayments: A company has to ensure repayment of loan on time; otherwise, they have to face severe penalties and their assets could be seized.

For example:

  • Jaypee Group of Noida mortgaged their office building against the loan which they defaulted on.
  • So, AXIS bank had to seize their headquarter situated at Noida.
  • Loss of principal and interest: As a business, if you fail to repay the loan, you can lose the principal and interest.
  • New project- Uncertainty of returns: When you start a new project, there is uncertainty about the success of the same.

4. Types of financial risk

  • Stock market risk: When you invest in the stock market, you face systematic risk such as:
  • War
  • Earthquake
  • Tsunami
  • Corona Virus
  • Interest rate risk: Market behaviour changes due to fluctuations in interest rates.

For example:

  • In Sri Lanka, interest rates raised from 6% to 12%.
  • As a result, businesses became unviable because they had to pay a higher rate of interest.
  • Liquidity risk: This means the company is out of cash to pay immediate payment to the supplier.
  • Credit risk: When you sell goods to anyone on credit, it is called "Credit Risk."
  • Currency risk: It is caused due to change in the currency value.

       For example:

  • You import something for 100 dollars and one dollar is of Rs.70 which means your expense is Rs. 7,000.
  • After 6 months, if the value of the dollar rises to Rs.75, you have to import the same thing for Rs.75,00.
  • Asset-backed risk: When you take a loan against the asset and you fail to repay the loan, the asset has to be auctioned. This is known as "Asset-backed risk".
  • Foreign investment risk: These risks include:
  • Political risk
  • Economical risk
  • Legal and regulatory risk

5. How to manage financial risk?

  • Identify financial risk exposure: You can identify financial risk exposure in the following ways:
  • The main source of revenue
  • Customer credit extend
  • Credit terms
  • Company debt
  • Sensitivity analysis
  • Quantify risk exposure: You can quantify risk exposure in terms of:
  • Numerical value
  • EMI
  • Monthly cash flow
  • Cash flow statement for 3  months
  • Take final decisions: Now, you have to make final decisions to:
  • Fix liability
  • Manage operating costs
  • Negotiate payment terms with suppliers

Thus, you should follow all these steps to manage financial risks.

Key Outcomes of the Video

  • Identify financial risk exposure through sensitivity analysis
  • Quantify risk exposure in terms of numerical value
CREDIT GOES TO BADA BUSINESS 

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