Question

How does risk affect a company's financial decisions? What risks should a CFO consider in making a decision? Name at least five and describe each.

Answer 1

There are many kinds of risks involved within a Firm. Business Risk, Opportunity Risk, Systemic Risk, Market Risk, Liquidity Risk and many more. Risks arise because of company's financial decisions, market demand and supply for the service or product offered and economical situations.

We'll see how risk affects a company's financial decisions:

• Financial risk affects the cash flows of a company, and this in return affects the company's financial decision in a way that the management may raise more money with the expensive interest rates, which again cause more debt obligations.
• Operational Risk affects when the business is not able to generate the expected operating income, or the revenue is not up to the mark. This affects the financial decisions to cut off the low demand-supply products or to cut the prices off on the product.
• Liquidity Risk affects when the business is not able to meet it's short term working capital requirements, and this may affect the financial decisions as raising more cash or to cut off the dividend distributions to the shareholders.

CFO should consider the below five points in making financial decisions:

1. CFO should consider restructuring the debt and make wise decisions on balancing the debt to equity and debt to assets ratio. This saves the company from Insolvency risk.
2. CFO should consider maintaining the cash flows with a continuous growth rate by looking into the cost and revenue metrics. This saves the company from cash risk.
3. CFO should consider Profitability Index and Net Present Value to pick a good project else he may face Opportunity Cost as a risk.
4. CFO should consider the product research and development to continue meeting the market's demand and supply.
5. CFO should consider looking into the working capital requirements, inventory management and short term debts so as not to be affected by the liquidity risk.