Business risk vs financial risk: What’s the difference and how do you manage them?

Written by
RMI Team (F)

As a business owner, you will often wear multiple hats and juggle multiple issues to run your company smoothly. One major issue that is high on the priority list is risk management. No business can be completely free of risk, which is why it’s critical that business owners know how to identify and reduce two major types of risk: business risk and financial risk.

Business and financial risk may share certain similarities, but they are distinct from each other and require different approaches to balance and mitigate them. So, how can you tell the difference between the two, and what can you do to minimise your risk exposure? Here’s how to distinguish between business and financial risk and the strategies to effectively manage them.

What is business risk

Business risk is fundamentally associated with the ability of the business to generate enough revenue and profit to balance its operating expenses. This risk fluctuates depending on numerous factors, including market and economic conditions, government regulations, consumer demands and more.
In addition, business risk can be broken down further into five main categories:

1) Security and fraud risk

Includes data breaches, cyberattacks, identity theft, and embezzlement.

2) Compliance risk

Pertaining to laws and regulations that apply to your business.

3) Operational risk

Internal, external, or a combination of both. For example, a pandemic that forces people to work from home or human error in an operational process.

4) Financial or economic risk

Risks related to market movements, foreign currency exchange rates, commodity price fluctuations and more.

5) Reputational risk

Providing faulty products or services, poor customer support experiences, negative publicity and more.

What is financial risk

While financial risk is considered a type of business risk, it has its own set of considerations and factors that require a different mitigation approach. Unlike business risk, financial risk is linked to the company’s borrowed capital and ability to service its debt. For instance, companies with a higher debt would have greater financial risk due to the possibility of defaulting on their loans.

Financial risk can be drilled down deeper into several different categories:

1) Market Risk

Changing market conditions such as slow adaptation to new consumer behaviour.

2) Credit Risk

Providing customers with financing options or the business’ payment and credit terms with its suppliers.

3) Liquidity Risk

How quickly a business can convert its assets to cash (asset liquidity) and its daily cash flow (operational funding liquidity).

4) Operational Risk

These include risks like manpower issues, potential fraud, lawsuits and more.

How companies can mitigate business and financial risks

Although there will always be varying levels of risk for any business, using the right strategies can reduce the amount of business and financial risk exposure.

Create a contingency plan and risk management framework

As a first step, ensure that you have a clear risk management plan in place based on your industry’s best practices to help you identify and prioritise the main types of risk to address.

Once you have determined this, outline detailed steps and procedures to manage your business and financial risks in order of importance.

Conduct pre-employment screening

A major part of business and financial risk includes operational, security and compliance risks. Reinforcing these areas will ensure that you minimise the ways your business can be compromised.

One method to do so is by having pre-employment background screening. With up to 75 per cent of HR leaders catching falsified information on resumes at least once in their careers, these background checks act as a vital layer of protection to mitigate fraud and reputational risks as they will help to verify important personnel information including educational qualifications, employment history and criminal records.

In addition, performing in-depth background research for suppliers and partners can go a long way in reducing security and compliance risks. By getting deeper insight into these entities, your business will gain a better understanding of your business partners, reducing potential compliance issues.

Additionally, screening new senior hires for their financial health is highly recommended, especially if they’ll have access to sensitive financial and business information.

Build a risk culture

Establishing a risk culture in your business can  ensure that all employees share the same mindset towards risk management. Business leaders must take the steps to be committed to developing this culture and be proactive to risks.

Raising risk awareness through communication and training, providing the right reporting channels and enforcing personal due diligence are also essential for mitigating business and financial risks.

Review financial health regularly

Ensure that you keep a close eye on business finances by reviewing and analysing your financial data on a regular basis. This will help you get a better understanding of your company’s financial health and guide you to making the right decisions when it comes to strategic financial planning.

By having regular reviews, you can also maintain accountability, keep figures accurate and make corrections if your business is headed into riskier territory.

Maintaining good financial health also means managing your cash flow and liquidity well. The right combination of credit use and plentiful cash reserves can help reduce your liquidity risk.

While business and financial risks can sometimes overlap, they often require different mitigation strategies. As such, businesses will need to prepare the right approaches to mitigate these risks. When it comes to getting suitable solutions for risk management, getting in touch with an expert like RMI can help make the process simpler. Contact us today to learn more about our business and financial risk management solutions.