Distinguish between business risk and financial risk - Essay Example

Financial Management August 10, Distinguish between business risk and financial risk. What gives rise to or causes each typeof risk?A business is a game of risks and rewards. Rewards in the form of high sales, good profits and strong brand equity; on the other hand are risks; the factors which can threaten the functioning of a business and if not dealt with in a planned fashion, can threaten the survival of the business. Any business can face risks; which are broadly categorized into business risk and financial risk.

Business risk pertains to the operations of the business and is faced when the business does not generate enough revenue to cover its operating expenses. Business risk can be divided into two subcategories; systematic risk and unsystematic risk. Systematic risk refers to the risk posed by the conditions of the environment, i.e. the possibility that the economy within which a business operates will experience a downturn; while unsystematic risk refers to the possibility that the specific sector of the economy in which a business operates will fail.

In order to protect against unsystematic risks, businesses try operating is a variety of sectors so that losses from one business can be offset by the profits from another. Since systematic risk pertains to the economy of a country, there is little that businesses can do to prevent against the dangers of this kind of risk.Several internal and external factors cause business risk. Internal business risk factors can be corrected by the business, however the external factors are beyond the organization’s control.

Internal factors broadly include operating costs, business structure and business efficiency. In order to reduce operating costs, businesses should look toward cost cutting measures or to increasing revenues such that costs are covered. Similarly, business structure and management policies should be tailored such that they enhance efficiency. The external factors that cause business risk include the change in demand for the product, unpredicted changes in the state of economies worldwide etc.

Another category of risk posed to a business is financial risk. Financial risk pertains to the financing structure of a business. It can pertain to risks associated with shares (in case of a public limited company) or with the debt structure of the business and occurs when a business fails to pay its creditors. This risk is business specific, since each business has its own financing structure and how it manages the structure depends on the business’s policies and strategies. Financial risks are of several types; market risk (risks associated with shares in the stock market), liquidity risk (risk of insolvency), credit risk (risk of default by debtors) and operational risk (risk arising from ineffective monitoring and control systems).

Credit risk arises from debtors who are close to bankruptcy or are otherwise unable to pay their debts. In order to prevent against this risk, businesses install stringent measures to verify the credentials of their debtors before conducting business on credit. Liquidity risk arises from being unable to convert assets into cash, or by fund mismanagement such that necessary cash is unavailable at a time when it is needed. If one player in the market is faced with such a risk it can have an effect on the economy as a whole in the longer term.

Events in the economy as a whole, unfavorable government policies etc. can have an impact on the market risk of a country. Operational risk arises from the inability of firms to install proper systems and controls on the running of the business such that in the long run they are unable to support the financing structure of the business. Given the recent events in the global economy, businesses are now ever cautious against the occurrence of these risks and try to develop techniques and mechanisms to guard against them.

Works CitedFarelly, L. “Sources of business risk” eHow.com. eHow. n.d. Web. August 10, 2011Guzman, O. “Differences between business risk and financial risk” smallbusiness.chron.com. Chron. n.s. Web. August 10, 2011 Lister, J. “What are the causes of financial risk?” eHow.com. eHow. February 6, 2011. Web. August 10, 2011