All companies and entrepreneurs want to achieve success. They have dedicated hours of effort and work, their money, and their future with the goal of generating a profit. However, in many cases, entrepreneurs and entrepreneurs forget that profitability is linked to another term: risk.
Financial risk is defined as the uncertainty that accompanies any investment in which it may not be profitable. Unprofitability may result from the poor reception of the product or service by consumers, by a change in the sector, or by the instability of financial markets.
Risk is a constant analysis equation; what varies is the percentage. In stock markets, investors have an indicator, “β,” that measures the systematic risk that a company can experience based on elements, including the type of business or the industrial or financial sector.
Companies with high risks suffer very sudden movements in their prices. The low values correspond to companies that are already consolidated and whose stock market oscillations are weaker.
There are different types of risk within the stock market:
Systematic Risk or Market Risk: refers to the possibility of changes in rates, oil prices, new government regulations, or changes in currency values.
Specific Risk: is that which affects only one sector or one company. It can be caused by poor financial management of the company, due to the appearance of a technological advance that destroys the need of the previous product, or by the failed expansion of a business to a foreign country.
However, there are other types of risk:
Credit Risk: is present when one of the parties to a financial contract does not comply with established obligations. For example, a bankrupt distributor; a customer paying in installments does not meet the quotas. These are risks that every entrepreneur must account for and evaluate.
Liquidity Risk: occurs when one of the parties to a financial contract has assets but does not have sufficient liquidity to assume the agreed obligations.
Operational Risk: is associated with poor management and company operations.
Economic Risk: covers the loss of competitive advantage in a market.
Legal Risk: occurs when a contracting party breaks the agreement or violates intellectual property rights.
Once you understand what a risk is and its various forms, the question then become: how do I avoid it?
When a project, business, or investment is being developed, you must be mindful that the risk consists of three parts. If each of them is thoroughly analyzed in the context of your business, then risk can be reduced:
- The cost and availability of investment capital: what capital do I have? What capital will I have during the realization process of the business or the investment, and how much backup capital is available?
- Ability to satisfy cash needs: plan the fixed and variable costs that you face and consider possible eventualities. To meet any of these types of expenses, capital must be available.
- The possibility of increasing capital: At what point in my process will my capital start to increase? Through what resources will I obtain income?
Having analyzed each of the parts that make up the financial risk reduces the chances of occurrence. However, there are additional factors to consider relating to risk:
Information: is another way to reduce risk is to evaluate profitability and future forecasts. The more information you have at your disposal, the less likely you will make decisions based on impulse.
Diversify: and invest in different projects with joint risk and those that offer safer future projections; both will be compensated.
The Savings or Plan B: is having extra capital for emergencies will reduce risk and allow you to act with greater freedom.
Derivative Contracts: are contracts whose value is subject to another principal asset known as the underlying asset. Underlying products typically include oil, metals, or financial assets.
Future Contracts: are purchase agreements in which the asset, the price, the quantity, and the date in which the transaction will be made are established. Both buyer and seller accept the obligations subject to market expectations that each one perceives. This type of contract generates stability since prices are pre-established and fixed despite movements in the stock market.
Risk is inevitable; however, the best strategy is to make decisions based on extensive research that informs us of our possibilities, costs, and benefits.