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

Risk is uncertainty of future happenings. Risk affects all the decisions companies make. For example, whenever a new project is undertaken, detailed analysis of risks involved is done to ensure that wealth is not destroyed. The various various types of risks are -

1. Credit risk or default risk- the uncertainty that the company won't be able to pay off the debt. CFO has to manage cash flows effectively so that debt holders dont give bad rating to the company or raise debt costs. Timely interest payments is essential.

2. Liquidity risk - it involves managing day to day operations using cash. Short term cash for operational activities should be present or else liquidity risk increases which can cause negative impact to the operations of the company.

3. Compliance risk - the laws should be abided by. No unlawful activity should be done.

4. Supply chain risk- suppliers who sell us and the distribution channel of us reaching customers can face several risk such as quality issues, labor issues, supplier not being able to supply.

5. Foreign exchange risk - exchange rate fluctuations can cause huge trouble for companies. Proper hedging is required.

6. Market risk - the interest rate fluctuations or political tensions can cause systematic risk.

Apart from it, other risks are also present like reputational risk, legal risks, strategy risks etc.