Question

Distinguish and explain the differences between business and financial risk and provide an example from a publicly traded company

Answer 1

Business risk is the risk that every owners of the business has to bear whether business will continue or not i.e the operational risk,the performance risk.

Whereas Financial risk is the risk of not being able to repay the finance acquired outside i.e debt.

The common differences between the two are-

1)Business risk is purely operational whereas financial risk is related with the repayment of debt capital.

2)Business risk can not be avoided whereas Finance risk can be avoided by not raising debt capital.

3)Business risk will continue as long as the business will continue whereas Finance risk will discontinue as soon as whole debt capital is repaid.

4)With the perpetuation and expansion of the business Business risk emerges while for generating a better return when capital base expanded by raising additional debt capital then Finance risk increases.

5)Systematic and innovative operation can minimize business risk whereas by reducing the debt capital base and by increasing equity financing,Finance risk can be minimized.

6)Business risk can be measured by monitoring the variation in operating Earnings Before Interest and Tax and Fianance risk can be measured by monitoring variation in Debt-Equity ratio,Financial Leverage etc.

Regarding publicly traded company when talking about TATA STEEL is an leader in iron and steel industry.

In India, favorable demand conditions, availability of skilled manpower and adequate iron ore reserves make India one of the most attractive regions globally for the steel industry.

So there is always risk of competitors in the industry that can be a issue for major business risk of TATA STEEL. Also volatility associated with economic cycles, long completion time for project execution, complex logistics,stricter norms relating to environmental clearances and regulatory approvals are the contributor for business risk measures. This external context, coupled with the internal environment, forms the basis their of operational risk.

While discussing about their financial risk,Non-renewal of mining leases resulting into higher purchases of raw materials from open market at higher prices and Stringent regulations and compliance resulting into increase in  liabilities and to meet up with higher purchase cost and increasing liabilities they are raising funds from domestic and international bond markets as well as from the banking system because of stricter FDI norms domestic liquidity is adversely affected thereby contributing a higher debt capital and higher financial risk.