difference between financial and business risk

Financial Risk

Financial risk refers to the chance a business's cash flows are not enough to pay creditors and fulfill other financial responsibilities. The level of financial risk, therefore, relates less to the business's operations themselves and more to the amount of debt a business incurs to finance those operations. The more debt a business owes, the more likely it is to default on its financial obligations. Taking on higher levels of debt or financial liability therefore increases a business's level of financial risk.

Business Risk

Business risk refers to the chance a business's cash flows are not enough to cover its operating expenses like cost of goods sold, rent and wages. Unlike financial risk, business risk is independent of the amount of debt a business owes. There are two types of business risk: systematic risk and unsystematic risk.

Systematic Risk

Systematic risk refers to the chance an entire market or economy will experience a downturn or even fail. Economic crashes, recessions, wars, interest rates and natural disasters are common sources of systematic risk. Any business operating in the market is exposed to this risk, and the amount of systematic risk does not vary between businesses in the same market. Therefore there is little small business owners can do to decrease their exposure to systematic risk.

Unsystematic Risk

Unsystematic risk describes the chance a specific company or line of business will experience a downturn or even fail. Unlike systematic risk, unsystematic risk can vary greatly from business to business. Sources of unsystematic risk include the strategic, management and investment decisions a small business owner faces every day. Investors decrease their exposure to unsystematic risk by diversifying their portfolio and holding ownership in a variety of companies operating in a variety of industries.

Effect of Risk on Worth

A business's exposure to risk negatively relates to worth. A business more exposed to risk is worth less than an identical business exposed to less risk. Reducing risk is therefore important not only in helping your business succeed but also in maximizing its value.