The two primary risks that every company has to face on a daily basis are business risk and financial risk, and contrary to common belief, they are not one in the same. Understanding these two types of risk is critical for keeping your company profitable and manageable, especially during times of economic uncertainty. Knowing the difference between financial risk and business risk is also important when it comes to speaking with investors, financial institutions, and other people or organizations that may have a financial interest in your company.
What Is Business Risk?
Business risk usually involves all of the risks attributed to the
business’s strategic decisions, with the exception of the company’s
financial decisions. Such risks could include the decision to introduce a
new product or service into the market, or a potential partnership with
another company. In estimations of business risk, internal efficiency
and production quotas are commonly measured to determine whether or not a
key business decision is worth the risk.
What Is Financial Risk?
A company’s financial risk is predominantly targeted at its
shareholders and those who own or buy the company’s stocks as this type
of risk is based on how a company’s finances are structured, and
traditionally focuses on corporate debt. Companies that rely heavily on
business financing are often considered risky.
What Affects a Company’s Business Risk?
There are several factors that can affect the business risk level of a
company. The fluctuations in demand for a certain product or service
can certainly affect business risk as this will have a direct impact on a
company’s profits. In addition, every time a competing company
introduces a similar product to the market, it has the potential to
drive down costs and sales, both of which can affect a company’s
earnings. Changes in business risk can also be attributed to external
factors like government actions and changes in consumer preferences as
well as internal factors like the company’s ratio of fixed to variable
What Affects a Company’s Financial Risk?
One of the most common things that can affect a company’s financial
risk is the quality of the financial system within its country of
operation. If a company is based in a country that has a poorly
functioning financial system or devalued currency, its financial risk
will usually be relatively high as the company’s holdings could easily
be eliminated. For most American-based companies, however, their
financial leverage is usually used to determine their risk level.
Financial leverage is a company’s debt to equity ratio. The more a
company relies on debt to finance the business, the higher their
financial leverage is and therefore, the company is a higher financial