Facilitate a financial risk analysis like a piece of cake

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Facilitate a financial risk analysis like a piece of cake

Most of the time, managers and investors do not recognize the crucial problems of the company. Due to the large amount of trivial problems they face, they simply miss them. Financial risk analysis is an essential tool that calculates different risk ratios in order to minimize the long-term problems of a business.

For this reason, financial risk analysis should be a priority in every business. With financial risk analysis, not only can you identify your risks, but you can also manage and reduce their long-term effect. In this article, we will see how to prepare a financial risk analysis in a simple and easy way.

Four simple and easy steps to prepare your financial risk analysis

The easiest way to prepare your financial risk analysis is to follow these four steps:

      1. Start by defining your problems – The first thing to do is to identify all of your critical stakeholders and how they influence the overall risk of the business.
      2. Apply risk analysis methods – Risk is an inevitable category that must occur in different phases of business operation. However, the risks must be recognized and managed in order to reduce the negative effect they have. Their impact can be identified and analyzed using key performance indicators. Valuable assumptions can be derived using the KPI as a tool. They are at the heart of a good financial risk analysis.
      3. Define your risk triggers – It is important to identify all triggers related to a certain risk. At the same time, you will have numerical indicators and narrative reports. Possible triggers can be: delayed cash inflows from customers, price fluctuations in the market, increased loan interest, inefficient business strategy and many more.
      4. Prepare the action plan – The last thing to do is to prepare an action plan. What should your company do to reduce these risks? How will they affect the income statement? Develop a set of activities and form an effective business strategy. Your plans should be long term and realistic.
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Leverage analysis

One of the ways to optimize a company’s risk is to measure it and then quantify it in the right way. Risk quantification can be done using a few valuable tools.

These are two types of the most important risks that a company can face:

      1. Operational risk
      2. Financial risk
Facilitate a financial risk analysis like a piece of cake

Operational risk

Operational risk Can be used to calculate a company’s breakea score and how it affects profits by changing its pricing structure. Higher operating leverage means expenses do not increase with increasing sales volume. For this reason, companies with higher operating leverage earn more revenue than other companies. However, it also means they are more exposed to bad business decisions that can lead to lower revenue.
You can calculate the operating leverage using this formula: let’s take a look at the example of operating ratio calculation to see how it actually works. Company A sold 500,000 widgets for each. The fixed costs are ,000, and it only costs per unit to make the widget.
As we can assume, a 10% increase in revenue will make a 13.3% increase in operating income:
10% * 1.33 = 13.3%
Calculating operating leverage also means calculating the world score of the business. From the formula, it is clear that companies with higher operating ratios can earn more revenue because they are not increasing their costs in order to make those sales.

Financial risk

Financial risk is tied to borrowed money. In order to increase production volume or purchase new modern technology, sometimes companies use other financial sources such as loans. Borrowed money or debt increases business financial risk. Therefore, the higher the amount of debt, the higher the financial risk.
You can calculate financial risk using the following formula: Financial ratio analysis is important for both owners and potential investors. For example, level 2 for financial risk indicates a risky scenario for the investor, because a company has doubled its debt to equity (e.g. debt is 0, equity is 0, financial risk = 200/100 = 2). If the level is lower than 1, the company is guaranteed by its own resources.
And it’s great. It is not possible to define an optimal value of the ratio because its value varies from company to company and depends on many internal and external factors. To be meaningful, financial risk ratios must be compared to other historical values of the same company or other forecasts.
However, consider them only as indicators. Combining them together can compose a fairly realistic picture of the company’s financial state. Ultimately, they will help you develop an effective strategy to improve your business results.

Define your problems, set your goals

Preparing your financial risk analysis can be a demanding task to do, especially if you do not have the necessary expertise. We can always help you find financial risks. Our employees have the knowledge and tools to give you the best possible solution in the end. you can always Contact us here or in the comments section. Feel free to do so!

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