Entrepreneurship is a dynamic dream, with its risk-to-reward ratio heavily weighing in favor of the former, especially in initial years. According to the 2023 statistics by Forbes Advisor, 20% businesses fail in their first year, 30% in their second, and approximately 50% within five years.
Financial aspect of business risks is driven by the possibility of a bad bargain in an investment. This could potentially lead to cash flow disruptions, debt obligations, and more. Thus, identifying the financial risks, assessing their potential impact on the venture, and creating combat strategies for them is essential.
Here’s the top four financial risk that business ventures have to inevitably deal with:
1. Market Risk
Market risk derives from change in the conditions of the market domain that the enterprise competes in. It can be directional like loan interest rates, stock prices, bonds, and so on. There can also be non-directional volatility risks like change in market dynamics such as the increase in online shopping community, posing a threat to traditional retail businesses.
Other market risks include being outmaneuvered by your rivals, the repercussions from the growing ESG trend, and more. In today’s cutthroat competition, it’s essential that enterprises have a unique proposition while seeking to do good in the community in order to minimize market risk.
2. Credit Risk
Credit risks generally involve settlement, whether it occurs due to a business extending credit to customers or its own credit towards suppliers. It is crucial for enterprises to take accountability of their own credit obligations by strategizing the availability of essential cash flow and pay their bills on time. The consequence could be that suppliers might stop extending credit or, even terminate the association.
Another aspect of credit risk is the implementation of challenging foreign exchange policies that drive the trading transactions, known as sovereign risk.
3. Liquidity Risk
Liquidity risks pertain to an enterprise’s failure in executing transactions. This arises due to asset liquidity risk or operational funding liquidity risk. Asset liquidity means a company’s ability to convert their assets to cash in case there is a substantial requirement of additional cash flow. It generally occurs due to an imbalance in demand and supply.
Operational funding liquidity refers to the essential daily cash flow that causes them to miss deadlines on their short-term monetary obligations. Seasonal downturns are a major factor at propelling liquidity risks. Thus, cash flow management becomes crucial, not only to continue production but also to appear a worthy equity investment to the analysts and investors.
4. Operational Risk
Operational risks arise from a degeneration of ordinary business activities. It includes fraud risk that occurs due to unexpected loss from fraudulent acts like theft, embezzlement, and so on. The other aspect is a business model risk that stems from strategically terrible decisions owing to inaccurate and inefficient models, such as technological disadvantages that fail to meet the business needs.
Financial risks need to be effectively managed and prepared for, otherwise dire consequences including lawsuits, catastrophic losses, and even bankruptcy can lead you to give up on your dream. Thus, it is a basic need for any enterprise to monitor trends in financial risk over time and efficiently analyze the magnitude of risks for a flourishing, financially and otherwise.