Financial Risks: What are they, types and how to manage them?

The financial management of a company is not a simple matter. Learn about the different types of financial risks and how to manage them properly.

What are financial risks?

The Dictionary of the Royal Spanish Academy, in its first meaning, defines risk as "contingency or proximity of damage" .

ISO 31000 defines risk as "the effect of uncertainty on the organization's objectives". 

The same ISO 31000 standard indicates that risk can be measured in terms of probability and impact: 

- Probability is "the possibility of something happening, defined, measured or determined objectively or subjectively, qualitatively or quantitatively, and described mathematically or in general terms (e.g. frequency)" .

- Impact is "the consequence of a risk occurring, which may be certain or uncertain, positive or negative, and evaluated qualitatively or quantitatively".

Among the aspects that may present risks, ISO 31000 lists the following: financial, market, health and safety, environmental, technological, communication and training, operational, organizational, cultural, among others.

Gustavo Nigohosian, author of Compliance Without Borders, lists three categories of risks, which coincide with the COSO Framework: "one has to do with the risk of effectiveness and efficiency of operations, another with the risk of information, mainly financial information, but also internal information of the company or institution we are talking about, and the risk of legal and regulatory compliance, both internal or internal standards, as well as external".

According to what has been analyzed, it is possible to outline a definition of financial risks: "financial risk, in a negative sense, is the contingency that may affect the company's finances, with greater or lesser frequency, causing high, medium or low damage to the going concern".

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Types of financial risks in a company

Financial risks are related to the current items of the Financial Statements. 

Current Assets are those assets owned by the company that represent cash or can be converted into cash relatively easily, providing liquidity to the company to meet its short to medium term obligations. They include: cash, checks, positive balances in bank accounts, short-term investments (foreign currency, fixed term, short-term investment securities), sales receivables to be collected in the short term, other short-term receivables, merchandise for resale, supplies and products in process to be sold in the short term. 

Current Liabilities are the debts acquired by the company that must be paid in the short to medium term. They include: commercial debts with suppliers, bank debts, tax debts, labor liabilities and other debts that must be paid in the short term, i.e., before the next close of the business year.

The usual financial risks, due to short-term operations, are as follows:

Cash and short-term investment liquidity risks 

Probability of being able to use balances in bank accounts, money in time deposits, foreign currency, securities, etc. as cash. 

Credit risks (assets)

Probability of default or even uncollectibility of receivables in favor of the company.

Operational risks

Probability of having problems in the manufacture of products and in the sale of goods or services. They may be caused by problems with the company's installed capacity (higher demand that cannot be met in the short term), by the competition, by lack of marketing actions, by a product that has reached the end of its life cycle, or even by reputational damage.

Credit risks (liabilities)

Probability of default or inability to meet financial obligations to third parties.

Conjunctural risks (liabilities)

Probability of higher tax burden or labor liabilities that could not be foreseen.

Compliance Risks

This risk is associated with the internal control of financial operations, because there are internal agents in the company who are constantly tempted to engage in activities of questionable legality in the short term.

Example of a conceptual map of financial risks

Financial risk audits to evaluate companies

The audit of financial statements is the audit par excellence in the business world. It allows to analyze the company's balance sheet after the close of each business year, but also to monitor the functioning of the company's key controls.

The key controls suggested by the auditor will make it possible to reduce the probability and impact of certain economic and financial risks, thus protecting the ongoing business.

Financial risks must have key controls at a higher level, i.e. rigorous controls, developed through segregation of duties, multiple authorizing signatures, exhaustive documentary controls to avoid payments that do not correspond, tax controls related to collections and payments, financial programming continuously monitored, balance sheets that reflect the financial reality of the company, among others.

How to manage a company's financial risks?

Technology is a great ally in the management of companies' financial risks, because it allows efficient and timely controls to reduce their probability and impact.

Integrated management systems, such as ERP, play a central role in the adequate financial projection of the company and the control of credit compliance and financial obligations.

A good example of this is Riskallay, the third-party risk management and assessment software that streamlines your processes.

They also make it possible to monitor the market to analyze whether sales are equal to or greater than projected, issuing indicators to verify whether it is necessary to stay ahead of the market and develop new products, and even to analyze the performance of the competition.

Third parties of the company, such as customers and suppliers, it is essential to monitor them 24/7 to indirectly reduce the financial risks associated with a lack of liquidity to meet assumed obligations.

In financial risk management, it is essential to incorporate a technological element, thus eliminating manual aspects that expose us to unintentional errors and outdated risk maps. Technology will make our process more effective and efficient, so that we can have a dynamic picture of each of the processes and actors that can seriously damage our reputation. 

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