Most businesses operate in extremely competitive landscapes and face several operational risks on its path to success. Small and medium sized (SMEs) businesses in particular are at a higher risk, making it important to define and control company policies to minimize, maintain and control risks on hand.
Financial risk management is the process of identifying risks that impacts the financial ability of the company. This process includes developing risk mitigation strategies that measures the impact and liability to help identify the necessary course of action. In simple terms, business risk is the ability of the business to make sufficient revenues or sales to cover for it costs and generate profits.
There are different types of risks a company could be exposed to, such as operational risk, credit risk, market risk, foreign exchange risk, interest rate risk and many more. Financial risks are more holistic and includes different classification of risks that can have an impact on businesses and its ability to manage its financial position viz a viz its debt and financial leverage (if any). An effective risk management framework seeks to protect an organization’s capital base and earnings without hindering growth.
Nayef Shahin, Founder and Managing Partner at Metis Management Consultancy, shares four fundamentals of risk management.
- Risk diversification
One of the fundamentals of risk management is diversification. Diversification strives to smooth out unsystematic risk events in a portfolio so the positive performance of some investments neutralizes the negative performance of others. Therefore, the benefits of diversification hold only if the securities in the portfolio are at risk.
- Measurement of Risks
Another risk management fundamental is the measurement of the risks involved. SMEs should constantly endeavour to understand and identify the risk faced by the company, and attempt to measure the risk, to identify what type of action is involved.
- Financial leverage on business risks
Financial risk is more related to the debt taken by the company, and that is why it is important for an SME to take measurable and limited financial leverage especially because the business risk of an SME is quite high.
- Finding the right balance between business and operational risk
Companies should find the right balance between business or operations risk, and the financial risk. The Financial risk appetite can be enhanced provided the business risk is limited and sufficiently eased.
To wrap it all up, it is important to highlight that financial discipline is the key to successful risk management in any business.