In today’s business world, there is a lot of potential risks, most notably financial risk. Financial risks present the possibility of losses primarily from credit risks related to various sources such as customers, suppliers and vendors, financing and liquidity risks, and market risks related to fluctuations in equity prices, and interest rates.
Luckily, there are many tools and techniques that you can implement and leverage to ensure that you aren’t in the red zone when it comes to financial risk. Generally, a risk management process is comprised of the following steps:
• Risk identification — Identifying the risks to which the organization is exposed to is usually the first step of the process
• Assessment — By leveraging a mix of qualitative and quantitative techniques, each identified risk is assessed to estimate the scale
• Prioritization — The risks are then prioritized through various methods, most commonly through a map of the estimated risks against a matrix that measures likeliness and impact
• Risk response — Businesses will then need to look at the assessment and come up with an action plan whether it may be to implement a tool or tactic
• Implementation — After coming up with an action plan to move forward with, the business would need to implement the plan and monitor its performance
With so many various methods available, it can be difficult to choose the right one for you. Here are a few financial risk management tools and techniques that can help you out:
Internal Strategies Internal strategies are essentially strategies where the business would accept the risk and manage it internally within the framework of normal business operations. For example, a company can make the decision to leverage the customer’s currency for exports pricing and use the internet net profit to manage currency exposures. These techniques are known as natural hedging and internal netting. Natural hedging tools are generally used to manage foreign exchange and interest rate risks while internal netting is for managing multiple internal exposures across a range of currencies.
Risk-Sharing Strategies Risk-sharing strategies are generally used to mitigate or share risks with an outside party thus decreasing the responsibility of your company. The two most common tools used in this strategy are forwards and joint ventures. A forward is essentially a contract created today for a future delivery of an asset at a specific fixed price, meaning that it would prevent any losses from unfavorable currency movements because it locks the buyer into a fixed future exchange rate. Joint ventures are a general contract that implies that one party is willing to accept a given level of risk, but it has the option to share that risk with another party. This is a great tool for companies to expand into a new market with shared knowledge to help reduce the cost.
The key to implementing the correct financial risk management tool is to create a risk-aware culture in your company so your business’ language and methods of operation are embedded with risk management. It’s important to assess all tools before implementing them to ensure that they are right for you.