Credit Risk Risk Management
4 mins read

Financial risk – What is it and why is it important?

What is the definition of financial risk? 

Financial risk represents the likelihood of an unfavourable outcome relating to personal or business decisions. The higher the financial risk exposure, the greater the chance of losing money or becoming indebted.  

Companies and individuals should take all reasonable steps to mitigate as much financial risk as possible to prevent scenarios of loss or hardship.  

What is a financial risk? 

So, what are financial risks? Any potential future financial loss can be considered a current financial risk. The examples of loss-making scenarios are extensive, including clients or debtors not paying bills, raw material shortages, international conflict, and many more.  

Any of these examples may potentially result in a loss for the business or consumer. If the risk is severe and the worst scenario eventuates, it could be enough to put them out of business.  

Why does financial risk matter?  

Businesses and individuals must earn more money than they spend to stay afloat and assessing financial risk is integral to achieving that aim. Understanding financial risk helps to reduce the potential downsides of adverse events – if they were to occur.   

The business or individual then uses that assessment to inform decisions. As a financial risk example: a business may choose not to deal with a Politically Exposed Person (PEP) or company from a destabilised area because of a higher likelihood that it will fail to recoup the expenditure.  

Business decisions must be assessed according to your financial risk definition. Perhaps the business you’re investing in suddenly runs into supply chain issues. Maybe you’re considering extending a line of credit to a new client with less payment information on record and are unsure of their ability to make timely repayments.  

If you’re unsure of where to begin, consider conducting a third-party assessment, such as a Full Financial Risk Assessment from CreditorWatch. Incorporating two to three years of company financials, this deep dive may help flag any of these issues well ahead of time to reduce cash flow exposure.  

Why is it important to understand financial risk? 

Failure to understand financial risk may result in a higher probability of default, insolvency or bankruptcy. Without an assessment of financial risk, some people can be blinded by the potential upside of a deal – the profits or benefits. Denying the potential of a negative outcome is only looking at half the picture. Many superficially attractive opportunities fall through for various reasons, so risk assessment must remain part of the due diligence process.  

Understanding and analysing financial risk takes a pragmatic approach, creating transparency for decision-making. Tools such as DebtorLogic from CreditorWatch allow your business to conduct transactions and seek new clients while keeping a watchful eye on the risk factors associated with your Aged Trial Balance (ATB). Without this automated 24/7 monitoring, if a client’s payment behaviour starts slipping, your business may suddenly find cash flow locked in accounts receivable with bills still to pay. It only takes a couple of clients to fall away on payments, and suddenly it’s an urgent situation.

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Who does financial risk impact? 

Financial risk impacts everyone. There is an associated risk with every decision a business or consumer makes – from the bank or super fund they use to their investment strategy, client approval, loan applications, and so much more. The types of financial risk vary from acceptable to over-exposed.  

No business or individual is immune from the potential of default or bankruptcy, even if they sit in a comfortable position financially speaking. Sometimes factors outside your control, such as war, political manoeuvring, or raw material shortages, can quickly change the risk climate. Ongoing financial risk analysis is vital, no matter what position you’re in or how confident you feel. 

Where can you find further information or support for understanding financial risk and its relevance? 

Seeking to learn more about financial risk? For individual consumers, consider consulting with a trusted financial advisor with intimate knowledge of your financial position to advise you of risk exposure. Each consumer will have a different risk balance they are happy with regarding investments, superannuation fun decisions, housing purchases and more. A trusted advisor can help navigate these crucial decisions with advice that relates specifically to you.  

For Australian businesses managing financial risk, the most comprehensive risk assessment of trading partners available to the market is the full Financial Risk Assessment from CreditorWatch. Deep dive into two to three years of company financials, including cash flow, income statements, balance sheets, adverse court notices, ASIC notices, and more. For high-value or high-volume trading relationships, the fate of your business may rest on engaging with the right trading partners. Provide essential peace of mind with this comprehensive financial risk management and analysis.  

Further, the payment behaviour of all business clients must be monitored for signs of deterioration or heightened risk. Conducting this exercise manually would be an enormous task, but DebtorLogic from CreditorWatch takes the hassle out. Monitor all clients automatically within your Aged Trial Balance (ATB) from the one trade payment platform, checking payment tendencies against industry averages and scanning for court notices or adverse events. As soon as vital information changes, the inbuilt 24/7 Monitoring and Alerts system emails you to allow as much time as possible to make the right decision.  

With the right tools leveraged for your business, assessing financial risk doesn’t have to be complex. Mitigate your risk exposure to bad debtors, protect your cash flow and grow your business with CreditorWatch.  

Speak to our expert team today.  

credit risk finance risk risk management
General Manager of Communication and Marketing
Mitchy is General Manager of Communications and Marketing at CreditorWatch. She is an expert communications specialist and with a special focus on media strategy to position businesses for maximum brand awareness and bottom line benefits, as well as positioning new and existing business leaders. From 2007 to April 2020 she was Head of Media & Corporate Communications for CoreLogic Australia & New Zealand and joined CreditorWatch in June 2020.
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