Difference Between Business Risk and Financial Risk

Business Risk vs Financial Risk
 

Since business risk and financial risk are very relevant topics to the world of business, identifying the difference between business risk and financial risk is crucial. The running of businesses involves a considerable amount of risk. It is important for business owners and entrepreneurs to identify and understand the various risks involved in running a business so that they can adapt their business strategies to deal with such risks in a better way. The following article takes a closer look at two such types of risks known as business risk and financial risk. The article offers a clear explanation of each type of risk and highlights the similarities and differences between business risk and financial risk.

What is Financial Risk?

Financial risk is the risk that a business will not be able to generate enough cash flow and income to pay their debts and meet their other financial obligations. Financial risk is more related to the percentage of leverage that a company holds and the debt that is used to finance business operations as opposed to the actual operations of the business. A company that holds a higher level of debt has a higher possibility of defaulting and not being able to meet their financial obligations. Therefore, companies with higher debt have a higher financial risk. Financial risk can arise from volatile interest rates, exchange rate risk, and company’s debt to equity ratio, etc.

What is Business Risk?

Business risk is the risk that a business faces in not being able to generate adequate income to cover operating expenses. Operating expenses of a business include utility costs, rent cost, wages and salaries, cost of goods sold, etc. Business risk can arise from a number of factors such as fluctuations in demand, market competition, costs of raw materials, etc. Business risk can be divided into systematic risk and unsystematic risk. Systematic risk is the risk of the downturn that is faced by the entire industry or economy. Systematic risk can be caused by a number of factors such as the recession, war, inflation, volatile interest rates, natural disasters, etc. Since these factors affect all businesses in one market or the entire economy, they are known as systematic risk. There is not much that individual business owners can do to combat systematic risk. Unsystematic risk, on the other hand, varies from one business to another. Unsystematic risk can arise from poor management decisions, strategic moves, investments, etc. The best method to reduce unsystematic risk is to diversify the portfolio of businesses held, by including businesses from different markets and industries into the portfolio. This means that even if one company is experiencing a downturn this can be overcome by the favorable performance in another business.

What is the difference between Business Risk and Financial Risk?

Depending on the type of business, industry, country in which the business operates and the top management the level of risk that a business faces can vary. It is important, however, that every business seeks to minimize their risk as businesses with lower risk have a higher possibility of success. The higher the risk a business has, the lower the company’s worth. However, it must also be kept in mind that certain business decisions involve considerable risk but also with the possibility of making a very high return. Therefore, business owners must make sure risks taken are well researched and calculated. The main difference between business risk and financial risk is that business risk is related to the business operations and not being able to generate adequate income to cover operating expenses, whereas financial risk is more related to the possibility of not being able to cover debt and meet financial obligations. Business risk is independent of the portion of the debt that a business holds, as opposed to financial risk that is very much influenced by the level of debt.

Difference Between Business Risk and Financial Risk

Summary:

Business Risk vs Financial Risk

• The running of businesses involves a considerable amount of risk. It is important for business owners and entrepreneurs to identify and understand the various risks involved in running a business so that they can adapt their business strategies to deal with such risks in a better manner.

• Financial risk is the risk that a business will not be able to generate enough cash flow and income to pay their debts and meet their other financial obligations.

• Business risk is the risk that a business faces in not being able to generate adequate income to cover operating expenses.

• Financial risk can arise from volatile interest rates, exchange rate risk, and company’s debt to equity ratio, etc.

• Business risk can arise from a number of factors such as fluctuations in demand, market competition, costs of raw materials, etc.

• Business risk is independent of the portion of the debt that a business holds, as opposed to financial risk that is very much influenced by the level of debt.