All companies face various risks that can affect their business activities' financial and operational success. Some risks can be anticipated and potentially preempted or mitigated, while others may be unexpected and unavoidable. Investors should look for known, disclosed, and potential unknown risks when evaluating investment options. Some types of exposure are common to all businesses, some might be specific to a particular industry or operational structure, and others could be individual or rare. Let’s examine some of the risks many companies face.
Credit risk. When companies offer credit to their customers, they accept the chance that the customer won't pay or will pay slowly. It is also a credit risk when a company uses credit to operate, expand, or make a change. If they cannot repay the loan, they may default.
Liquidity risk. If a business has assets but can't convert them into cash quickly, that is liquidity risk. This can be a problem if the company needs money suddenly or unexpectedly and does not have a “liquid” supply.
Operational risk. If the business suffers from a breakdown in a critical piece of equipment, that is an operational issue. The risk of that kind of occurrence is operational risk. Other examples are things that can disrupt regular business, like a strike or a natural disaster (flood, fire, pandemic).
Reputational risk. This is a risk that someone or some event will cause the public to dislike the company. Examples include negative publicity about a customer service situation that attracts significant attention or a senior executive captured on video or audio expressing unpopular opinions. Reputation damage can also occur due to actual events like products that cause injuries.
Compliance risk. Companies can face compliance exposure when they fail to adhere to applicable rules for their business or operation fully. If a company discriminates, this causes both compliance and reputational risk. Failure to file accurate tax returns is a compliance risk issue.
Exchange rate risk. The risks of exchange rates are the potential for negative impact caused by exchange rate fluctuations. There are three subcategories: transaction risk, economic risk, and translation risk. These risks are primarily faced by companies that trade across borders and conduct business internationally.
- Transaction risk is the potential for a change in the exchange rate after the transaction occurs and before settlement. For example, if the rate falls for the currency in which the transaction is being settled, the company can incur a lower-than-expected receipt.
- Economic risk is a broader risk of damage to a company's value caused by exchange rate volatility. For example, if a business is often or unexpectedly affected by exchange rate changes, the company’s stock price may reflect the volatility by dropping.
- Translation risk happens when reported financials change due to exchange rate changes. For example, if a company in one country publishes results using the currency of a different country, and the exchange rate for the two currencies later changes, the financial result looks different.
All investments have risks, and each investor must evaluate them based on their risk appetite and tolerance.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
