Financial risk: What it is, characteristics and importance - GovtVacancy.Net

Financial risk: What it is, characteristics and importance - GovtVacancy.Net
Posted on 25-10-2022

Financial risk: What it is, characteristics and importance

The financial setbacks that an investment carries with it, is what is known as financial risk. This concept makes it possible to reveal the different (negative) scenarios that may exist and affect an organization if an investment goes wrong.

For this reason, financial risk as an analysis is of the utmost importance for companies, since it allows them to know how likely it is that one eventuality or another will happen, and depending on the result, make a decision accordingly.

Definition of financial risk

Financial risk is defined as the probability of the occurrence of an unfavorable event capable of negatively affecting the finances of a company. It refers to the possibility that some investment does not generate the expected profits or that, even, you cannot recover your initial investment.

This concept can also be associated with the investments made by an individual person, since their investment decisions are also subject to certain financial risks, and which, therefore, they take into consideration to take care of their personal finances.

In every investment there is a financial risk, and its percentage must be calculated to determine if an investment is worthwhile or not.

Generally, when an investment offers high returns, the risk is higher. On the contrary, when the gains are modest, the risk is lower.

Types of financial risks

  • Market risk: It refers to the probability that an asset will lose its value due to market fluctuations.

  • Credit risk: It is the possible loss that an economic agent (company, State, bank or person) accepts for failing to comply with any financial contract obligation.

  • Liquidity risk: It is understood as the possibility of not obtaining liquidity quickly enough and at the corresponding value (selling assets to obtain cash without much delay or loss) in order to comply with the obligations indicated in the financial contract.

  • Operational risk: It is the probability of obtaining financial losses due to failures in a company caused by human errors, imperfections in processes, defective systems, technological failures and other external factors.

Characteristics of financial risk

  • Defines the consequences of adverse events that affect the financial health of an organization.

  • Indicates the uncertainty of the return of an investment due to different economic factors (fluctuations in the market, breach of a financial contract by one of the parties and changes that could be generated affecting the return of an investment).

  • Financial risk is closely related to the return on an investment. The higher the profit, the higher the risk, and vice versa.

  • He points out that no investment is safe, since future scenarios are uncertain even with a thorough investment analysis.

Importance of financial risk

Financial risk allows knowing the consequences that a certain investment can have on the finances of a company or investor. Therefore, any investment can be made conscientiously knowing its risks, which helps to decide if the negative scenarios that are contemplated can be assumed or not.

Likewise, it helps to reveal if the profits offered by an investment are worth the risk that it entails.

Given this, it is essential to carry out a financial risk analysis to prepare for any eventuality and not be seriously affected.

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