Understanding Business Risk and Financial Risk: Types & Differences

Imagine a clothing brand that has found itself gaining unprecedented popularity and increasing revenue. This forces the owner to keep asking banks for loans and handle operations among her small staff. This puts both her business and her investors at risk.

Running a business comes with all kinds of threats, like strategic or operational risks. Business and financial risks are two such risks that a company needs to expect and manage.

Even solid risk management can sometimes merge two threats that need different plans. This is why you should understand the difference between business and financial risks for your business.

In this blog, we’re going to understand business and financial risks. Let’s find out what their differences are before you strategise risk management. Find their differences, types, and ways to manage them.

What is business risk?

Business risk means a company might not reach its goals due to unforeseen challenges. For example, a new restaurant opening in the middle of a pandemic.

Business risks come from competition, changes in the economy, and government regulations, which affect the business’s profits, reputation, and survival.

Understanding business risk and how it’s created will help your company plan out strategies. So let’s take a look at them:

1. Market competition

If a company cannot offer better prices, quality, or service than its competitors, it may lose customers and revenue. For example, an organic produce store opens near an established chain like D-Mart. It may find it difficult to attract customers due to the larger store’s range of products and discounts.

Companies should find ways to stand out, such as offering personalised services or unique products.

2. Regulatory changes

Regulatory changes are government rules that modify tax policies, labour laws, or environmental rules. They require businesses to change their operations. Ignoring such changes can lead to fines. For example, if a government bans plastic, a packaging company must switch to more expensive alternatives.

3. Operational inefficiencies

Operational inefficiencies refer to a company not using its resources with careful planning. It happens because of poor operating models within the company.

Over-focusing on factors like overworking your employees and ignoring automation and HR training can waste time, money, and resources. For instance, a manufacturing company using slow and unreliable machines will produce fewer goods than competitors and spend more on repairs.

What is financial risk?

Risk in financial management is the chance of losing money due to market changes or economic conditions. This type of risk doesn’t only affect investors, it can backfire on the business itself. Understanding financial risk helps businesses make smart decisions and avoid losses.

Let’s take a look at the types of financial risks:

1. Credit risk

Credit risk occurs when a borrower cannot repay a loan. Factors like defaulting, the inability to repay loans and interest cause credit risks. Banks, lenders, and businesses that offer credit face this risk when a company is in debt. So, if a business defaults, its investors lose money.

2. Liquidity risk

Liquidity is the ability to quickly convert assets into cash without losing value. There are two types of liquidity risks: Market liquidity and cash flow liquidity.

Market liquidity risk happens when businesses cannot sell their assets without losing value. For example, a company with a large amount of stock in a small company cannot sell it without reducing its price.

Cash flow liquidity risk occurs when a company does not have enough capital to pay for short-term expenses. A business owns assets, but without cash, it cannot pay bills, salaries, or suppliers on time.

3. Market volatility

Market volatility is one of the factors that a company cannot control. Sudden price changes in stock and inflation are examples. These changes depend on economic conditions, political events, or investor behaviour.

For example, a sudden increase in oil prices raises fuel costs for aeroplanes, and airlines have to suddenly change their finances.

Business Risk vs Financial Risk

Let’s take a look at the main differences between business risks and financial risks to understand them.

Business risks look at the bigger picture the company can face if things go wrong. Risk in financial management predicts the monetary risks a company might face.

Managing business risks effectively

The first step to managing any risk is to understand and identify them. Why are they happening? Where is it going wrong? What needs improvement? Once you have answered these questions, you can begin factoring the next steps:

Risk control management (RCM)

RCM is the process that spots, analyses, and prepares for risks. Businesses need a dedicated team for this process that detects, evaluates, and addresses probable risks. This includes setting up clear policies, training employees, and using risk assessment tools like SWOT analysis or Porter’s model.

For example, a healthcare institution will use the Bowtie model to keep its data secure from cyber threats. This will help it access sensitive patient data and provide healthcare immediately.

Tracking market trends

Forming specific teams to keep an eye on market trends and changes in government policies avoids uninformed decision-making. These teams will also be in charge of improving workflow and upgrading technology. A bonus is that this will help our business stay on top of competitive trends.

Better internal operations

Avoid internal inefficiencies like miscommunication or keeping some teams in the dark for smooth internal workflows. If these inefficiencies are not fixed, profits will drop, and the business may not survive.

Strategies to mitigate financial risks

Companies must identify risks early and create strategies to handle them before they cause damage. Here are some ways you can save your business from falling into financial risks:

Insurance and investments

Always keep insurance to protect your business against unexpected losses like property damage, lawsuits, or employee injuries. Liability insurance protects if an accident occurs on-site. If you spend on damage caused by natural disasters, you should have business interruption insurance.

Investments, like expanding into new markets, can also reduce risk by diversifying revenue. Invest in hedging strategies like options and futures to protect your business from market fluctuations.

Enterprise resource planning (ERP)

ERP systems help businesses manage operations by integrating finance, supply chain, and human resources into one platform. This improves decision-making and reduces unnecessary mistakes. For example, a manufacturing company that uses ERP can track their inventory levels in real-time to avoid shortages or excess stock.

Real-world examples of business and financial risks

Let’s take a look at some businesses that succumbed to business and financial risk examples:

1. Toys “R” Us

Toys “R” Us is a private children’s toys retail company founded by Charles Lazarus in 1948. It was popular during its initial days since children could go in and play around.

It had also acquired Baby Superstore and rebranded it Babies “R” Us, which gained more fame than its parent company. Toys “R” Us shut down in 2018 since it went bankrupt with a debt of USD 1.86 billion^[1].

Although Toys “R” Us filed for bankruptcy protection^[2], finance was not their first step to reaching this state. Their biggest problem was their business model. After being a conglomerate seller of toys, they did not realise their competition lay with Amazon and other online retailers.

They did not integrate their services online early on when every other business realised the potential of online services. Their late entry into digital shopping was a big part of their decline. Although they now have an online store, their revenue and profits are a lot less than what they used to be.

2. Kingfisher Airlines

Kingfisher Airlines was launched by Vijay Mallya in 2005 in India. It became one of the leading airlines. Despite this success, the airline faced huge losses. The causes were high operational costs, poor financial planning, and an unpayable debt of ₹7,000 crore^[3].

The airline’s problems worsened when it acquired Air Deccan, which failed to achieve its target vision. Investments in high-investment areas like F1 were also part of KFA’s downfall. Rising fuel prices, high taxes, and an unsustainable business model added to their finances.

By 2012, Kingfisher aircraft were grounded, and their employees were protesting since their salaries had remained unpaid for months. The Directorate General of Civil Aviation suspended its license in October 2012 due to operational failures. By 2015, Kingfisher had a total loss of ₹9,091.40 crore.

Identify risks early with GrowthJockey

Understanding business and financial risks is important for any company’s survival and growth. Business risks come from competition, regulatory changes, and operational inefficiencies. Credit issues, liquidity problems, and market volatility cause financial risks.

Many times, companies fail to address these risks because of a lack of awareness, time constraints, or focus on short-term goals. GrowthJockey - Full Stack Venture Builder In India is identifying risks early and taking proactive steps. This can protect your business and help it thrive in a competitive market.

Our experts are trained in tracking trends that best fit your industry so we can apply them to your growth. Contact us for business and financial risk strategies personalised for your business.

FAQs On Business Risk and Financial Risk

1. What do you mean by business risk and financial risk?

Business risk refers to threats that affect a company’s operations and profits. Its causes are competition, regulations, or internal inefficiencies. Financial risk is the possibility of monetary losses due to poor credit management, liquidity shortages, or market fluctuations.

While business risks impact the entire company, financial risks affect cash flow, borrowing ability, and investment returns.

2. What are the 4 types of financial risk?

The four main types of financial risk are:

• Credit risk: Where borrowers fail to repay debts

• Market risk: Where stock prices or currency values fluctuate

• Liquidity risk: This includes cash flow shortages or difficulty selling assets

• Operational risk: This arises from internal failures like fraud or mismanagement

Businesses must track and manage these risks to maintain financial stability and avoid losses.

3. What are the types of business risk?

Business risks include:

• Strategic risk: This comes from poor decision-making or changing market trends

• Operational risk: Inefficiencies, supply chain issues, or technical failures cause this

• Compliance risk: Which arises from legal or regulatory violations

• Financial risk: This affects a company’s capital and investment health

Effective risk management ensures businesses stay competitive and compliant.

4. How to measure business risk and financial risk?

You can measure business risk by analysing market conditions, competitor strategies, and operational performance using tools like SWOT analysis and risk assessment models.

Measure financial risk using key indicators like debt-to-equity ratio, liquidity ratio, credit scores, and market trend analysis.

Regular audits and financial planning help businesses expect and avoid potential risks before they become major issues.

5. What are the examples of risk in business finance?

Examples of risk in business finance include debt default, where a company cannot repay loans. Stock price drops, which affects investor confidence. Interest rate hikes increase borrowing costs. Currency fluctuations, which impact international trade.

Additionally, unexpected events like economic recessions or inflation can weaken financial stability. Businesses reduce these risks by diversifying investments, maintaining liquidity, and using risk management strategies like hedging.

1. USD 1.86 billion - Link ↑
2. filed for bankruptcy protection - Link ↑
3. ₹7,000 crore - Link ↑