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 various kind of risk involved in firm like; Business risk, Opportunity risk, Systemic risk, market risk, liquidity risk and many more.

Risk arise sometimes due to company' s Wrong financial decisions, demand and supply of products or services offered by the company or any other economic situation.

Let's see how the risk affects the financial decisions of the company:

- Financial risk affects the cash flow of the company and consequently affects the company' s financial decisions.

Due to shortage of fund , business may take the decision of raising fund with high rate of interest.This step can increase the burden of debt obligations unnecessarily.

- Operational risk affects when the business is not able to generate the operating income or revenue is not as per expectations.

In that case, financial decisions can be taken for lower demand supply products or cutting off the price of the products.

- Liquidity risk affects when the company is not able to meet its short term working capital requirements. Again, it will affect the financial decisions. Management will either raise more fund or would take decision of cutting off the percentage of dividend distribution to the shareholders.

CFO should consider the below mentioned five points while making financial decisions:

1. CFO can save the company from cash risk by maintaining the cash flows with continuous growth rate by observing into the cost revenue metrics.

2. CFO should consider restructuring the debt and make wise decision on balancing the debt to equity ratio and debt to asset ratio. By this step he can save the company from insolvency risk.

3. At the time of picking of good project, CFO can consider profitability index and Net present value. If he could not do so, he may face the opportunity cost as a risk.

4. CFO should consider R& D kind of work for increasing the quality of product. Continuous feedback processing from customers and timely meet of demand and supply.

5. CFO should consider to look into the working capital requirements, inventory management and short term debts so that liquidity risk could not affect the company.