For an investor, it is pretty essential to know about the business and financial risk before investing any amount of money.
The definition of Business Risk is that business risk is concerned with whether or not a company will be able to make enough money that will be responsible for the functioning of the company.
On the other hand, Financial Risk is concerned with the usage of debt in the company. If a company cannot pay its debt, it might go insolvent.
Key Takeaways
- Business risk refers to the risk associated with a company’s operations, such as changes in the market or competition.
- Financial risk is associated with a company’s economic structure, such as debt levels or interest rates.
- Business risk is generally considered more unpredictable, while financial risk can be managed through financial planning and analysis.
Business Risk vs Financial Risk
The difference between Business Risk and Financial Risk is that financial risk is all about meeting financial obligations in order to avoid bankruptcy. However, business risk is the risk of whether the company will be able to function as a profitable enterprise. Financial risk arises due to variations in financial assets, currency rates, etc.
Business risk occurs because of changes in market conditions, requirements of the customers, etc.
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A company has to pay its interest payments or other forms of debt to avoid financial risk. Not using any form of debt will also limit this risk to absolute zero.
Business risk can’t be minimized as it is based on the revenue that is required to keep a company in business.
Comparison Table
| Parameter of Comparison | Business Risk | Financial Risk |
|---|---|---|
| Meaning | The risk of not being able to generate sufficient revenue is required for the proper functioning of the company. | It is the risk of not being able to pay the debts, which might result in making a company insolvent. |
| Concern | It is concerned with keeping the company operational. | It is concerned with the company paying its debts. |
| Way of Minimizing | It can’t be minimized. | It can be minimized from very little to no risk by not using debt capital at all. |
| Duration | As business risk can’t be avoided, it will always be there. | As the company reaches a certain level of equity financing, there will be no financial risk. |
| Role | In order for a company to grow, the business risk needs to be there. | It is considered to get better returns. Therefore the company ends up taking the debts. |
What is Business Risk?
Business Risk is the risk of not being able to make enough money to keep a company operational.
This risk arises due to changes in the conditions of the market, the requirements of customers, and the rules & regulations of the government.
It is unavoidable but can be handled well by focusing on the production process. The goal should be to minimize the cost the production is eating up. This risk does not allow a company to meet its daily expenses.
Any change that occurs in the micro and macro environment affects the business directly. This is what elevates the risk. Business risk affects the business value of the company.
This risk is totally related to company operations. Business risk determines whether any profit will be made or not by the company. Every expense that a company needs to consider in order to remain operational concerns the business risk.
Some of these expenses are the salaries of the employees, the cost of production, the rent of the facility, etc.
What is Financial Risk?
It is the risk when a company is not able to manage its finances and becomes insolvent. This happens because of liquidity risk, market risk, etc.
To put it simply, financial risk arises when a company is not able to pay its debts.
The risk occurs in the first place by letting the use of debt finance in the company’s capital structure. This is all done to ameliorate financial leverage. A company’s capital structure might be formed of equity or debt capital.
A levered firm is a term given to companies whose capital structure is made up of debt finance. On the other hand, un-levered firms are free of any debt.
Now, debt funds are a quick and cheap way to fund a company, yet they are a risk for all shareholders. When a company winds up, the creditors are the first one who gets repaid, not the shareholders. So, this is what makes it a risk for all shareholders.
Main Differences Between Business Risk and Financial Risk
- The business risk concerns the company’s inability to make enough money to keep its operation going without any hassle.
Financial risk concerns a company’s inability to pay its debts. This is what makes a company go bankrupt. - Business risk cannot be avoided. However, it can be taken care of properly by reducing the cost of production.
Financial risk can be avoided by not using debt funds in the company’s capital structure. - Business risk can be evaluated by considering the company’s earnings (not including taxes).
On the other hand, financial risk can be evaluated through the debt-to-asset ratio. - Changes in market conditions trigger business risk, while changes in currency rates and financial assets cause financial risk.
- Some of the risks that business risk includes are strategic risk, reputation risk, etc. Financial risk includes liquidity risk, equity risk, etc.
- https://wuve.pw/wp-content-financial-institutions.pdf
- https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1745-6622.1993.tb00232.x
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
Risk assessment helps us in avoiding it in the first place. You have given great resource on this topic.
whether you take business or finance, risk assessment and mitigation is important.
Thanks a lot for the information provided here.