Essay, Pages 5 (1081 words)
Risk is inherent in life and risks are an inevitable consequence of being in business. Risk is the likelihood of losses resulting from events such as changes in market prices. Events with a low probability of occurring, but that may result in a high loss, are particularly troublesome because they are often not anticipated. Put another way, risk is the probable variability of returns. Risk is usually associated with the possibility that things might go wrong, that events might turn out worse than expected or that something bad might happen.
However, risk has a broader meaning. Risk exists whenever a future outcome or future event cannot be predicted with certainty, and a range of different possible outcomes or events might occur.
Risks can be broadly classified into two main categories, namely; pure risks and speculative risks. Pure risk, also called downside risk, is a risk where there is a possibility that an adverse event might occur. Events might turn out to be worse than expected, but they cannot be better than expected.
Speculative risk on the other hand also called two-way risk, exists when the actual future event or outcome might be either better or worse than expected. An investor in shares is exposed to a speculative risk, because the market price of the shares might go up or down. The investor will gain if prices go up and suffer a loss if prices go down (ICAN, 2014)
Companies usually face both pure risks and speculative risks, pure risks are risks that can often be controlled either by means of internal controls or by insurance.
These risks might be called internal control risks or operational risks, whereas Speculative risks cannot be avoided because risks must be taken in order to make profits. As a general rule, higher risks should be justified by the expectation of higher profits (although events might turn out worse than expected) and a company needs to decide what level of speculative risks are acceptable. Speculative risks are usually called business risk, and might also be called strategic risk or enterprise risk. The categories of risk common to many types of business include market risk, credit risk, liquidity risk, technological risk, legal risk, health, safety, and environmental risk, reputation risk, business probity risk and so on. Business risks are strategic risks that threaten the health and survival of a business.
Risks differ between companies in different industries or markets. Companies in different industries might face the same risks, but in some industries, the risk might be much greater than in other industries. For example, credit risk is a very significant risk in the financial services industry, but less significant in the oil industry. In contrast, the risks of environmental regulation are much higher for oil companies than for the financial services industry and also risks vary in significance over time, as the business environment changes. Companies need to be alert not only to new risks but for changes in the significance of existing risks. Are they giving too much attention to risks that are no longer significant? Or have they ignored the growth in significance of any risk that has existed for a long time, but is now much more significant than it used to be.
Companies are engaged in business, and for that matter, risks are also involved in the business they undertake most especially that of financial risk. Around the world, these companies deal with the different category of risks which have a direct impact on the performance of companies. These risks prove to be a greater setback in the process of achieving organizational goals and growth in terms of size, assets, and performance of the company which is measured in the form of returns. Thus, such a crippling situation in the organization necessitates a better approach being in place in order to understand these risks and develop an instrumental structure or framework to handle such risks. The key risks which hamper the performance of most insurance companies include credit risk, liquidity risk, re-insurance risk, solvency risk, technical provisions risk, and underwriting risk among others.
Financial risk is the uncertainties resulting from financial markets. It involves assessing the financial risks facing an organization and developing management strategies consistent with internal priorities and policies. Addressing financial risks proactively may provide an organization with a competitive advantage and it also ensures that management, operational staff, stakeholders, and board of directors are in agreement on key issues of risk.
In the world of finance, financial risk has increased significantly in recent years. The result of increasing global markets is that, risk may originate with events thousands of miles away that have nothing to do with the domestic market. Information is rapidly available, which means that change, and subsequent market reactions, occur very quickly. The economic climate and markets can be affected very quickly by changes in exchange rates, interest rates, and commodity prices. Counterparties can rapidly become problematic. As a result, it is important to ensure that financial risks are identified and managed appropriately.
The performance of firms indicates their capacity to generate sustainable profits. Companies protect the profitability against unexpected losses, as it strengthens its capital position and improves future profitability through the investment of retained earnings. Firms that persistently make a loss will ultimately deplete its capital base which in turn puts equity and debt holders at risk. In order to correct shareholder value, firms’ returns on equity (ROE) need to be greater than their cost of equity.
Financial performance is the act or result of performing financial activity. In a broader sense, financial performance is the degree to which financial objectives are being or has been accomplished. It is the process of assessing the results of a firm\’s policies and operations in monetary terms. It is used to measure a firm\’s overall financial health over a given period of time and can also be used to compare similar firms across the same industry or to compare industries or sectors in aggregation. Financial performance is a desirable objective for all profit-oriented firms. The absence of it can indeed spell failure (Yahaya & Lamidi, 2015). Financial performance is a measure of how well a firm can use assets from its primary mode of business and generate revenues. This term is also used as a general measure of a firm\’s overall financial health over a given period of time and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation.