The world economy is full of opportunities and risks. On the one hand, investors, lenders and borrowers can benefit from diversity, innovation and efficiency in financial markets, and on the other hand, fluctuations, collapses and crises can cause huge losses and severe economic repercussions. Therefore, all those who handle money must be aware of these risks, and how to deal with them.

In this article, we will provide an overview of these risks, their most prominent types, the methods used to measure and control them, and how to manage financial risks effectively.

The concept of financial risk management in companies and organizations

Risk management is the process of identifying, evaluating, mitigating and monitoring the risks facing establishments or companies in the financial markets. Types of financial risks may include losses resulting from changes in asset prices, interest rates, exchange rates, inflation levels, credit deficits, financial fraud, or legal violations. Therefore, any financial risk management process aims to protect capital and increase value by making investment decisions. This means informed, sensible, and balanced financing.

This mechanism relies on a set of financial and accounting tools, techniques, standards and practices to analyze, classify, reduce and transfer these financial risks.

This field is an important and complex field, and requires knowledge, experience and skill to manage these risks with the highest levels of efficiency.

Causes of financial risks

There are many reasons that may cause financial risks within a business, including:

High debt ratio: When any organization or business borrows money from banks or other parties at a specified interest rate, it is vulnerable to inability to repay debts and interest in the event of an economic crisis, a decrease in revenues, or an increase in costs.
High interest rates: When market interest rates rise, it increases the cost of borrowing for institutions and individuals, and reduces the value of fixed-income assets such as bonds and certificates. High interest rates also negatively affect supply and demand, consumption and investment, and reduce economic growth and expected profits. Consequently, businesses are exposed to the risk of loss due to the decline in the value of their financial portfolios or the inability of their customers to pay debts or interest.
High inflation rates: When inflation rates rise in the economy, this will mean a decrease in the purchasing power of the currency, and an increase in the costs of production and living. This rise will also cause fluctuations in the prices of goods and services, making it difficult to predict the financial future. Consequently, enterprises and businesses will experience losses due to the decline in the value of funds deposited, invested or borrowed.
Change in economic policies: When regulatory bodies change their economic policies that affect financial markets, such as monetary policy or tax policy, this will lead to a change in the financial conditions and expectations of institutions and individuals, in addition to affecting relations, trade exchanges, and foreign investments, so supply and demand decrease, and income and profitability decrease.
Financial market volatility: when financial markets are affected by internal or external factors, such as geopolitical events, natural disasters, health crises, technological innovations, social trends or consumer behaviours; This leads to a change in the prices and values of financial assets such as stocks, bonds, currencies, etc. In addition to the impact on levels of confidence, morale, and mood among investors, lenders, and borrowers; As a result of all this, establishments and businesses will be exposed to losses resulting from any sudden decrease or increase that occurs in the prices and values of these assets.
Lack of oversight and oversight of financial institutions: When financial institutions and companies lack good mechanisms, standards, and practices for monitoring and supervising their activities, transactions, and risks, they are exposed to fraudulent practices or financial abuses such as embezzlement, seizure, or hacking.
Regulatory and administrative errors in the banking sector: When regulatory and administrative bodies in the banking sector fail to develop, implement, monitor and evaluate laws, policies, procedures, standards, indicators, reports, reviews and audits to ensure the safety, efficiency, effectiveness, responsibility and comprehensiveness of the banking sector, this entire sector is exposed to significant financial losses, with businesses and organizations incurring financial losses too.

The importance of financial risk management

Identifying risks: Risk management helps establishments and companies identify potential risks they may face in the financial markets, and analyze their sources, causes, impact, and probability of occurrence, enabling them to make appropriate decisions to avoid or reduce these risks.
Asset protection: Financial risk management protects the assets of establishments and companies from losses that may result from changes in interest rates, exchange rates, inflation levels, credit deficits, or exposure to abuse or fraud. Which enables it to maintain its value, reputation and position in the market.
Enhancing the establishment’s position: Risk management helps establishments and companies increase their value by making informed and balanced investment and financing decisions, based on an analysis of risks and expected returns, making them more capable of achieving higher profits and distributing greater rewards to shareholders, employees and customers.
Enhancing the ability to adapt: By managing financial risks, establishments and companies can enjoy greater flexibility and ability to adapt to changes and challenges in the financial environment, increasing their ability to exploit opportunities and confront risks better, faster, and more efficiently.

Strategies to mitigate financial risks in businesses and organizations

There are many strategies that any business can follow to try to mitigate financial risks, including:

Diversification: that is, distributing investments across a variety of assets, sectors and markets, so that the value of the financial portfolio is not significantly affected by the fluctuations or losses of a particular asset.
Hedging: is the use of financial derivative contracts, such as futures, options and swaps, to secure a specific price or rate for financial assets or liabilities, so that the negative impact of changes in the market is reduced.
Analysis: is the use of mathematical, statistical, and computer models and tools to measure, forecast, simulate, and test various scenarios of financial risks, and determine the appropriate level of tolerance and risk.
Development: i.e. developing and implementing strategies, policies, procedures, standards, indicators, reports, reviews, audits and training to effectively and continuously manage financial risks in the business.
Compliance: Any business must adhere to laws, regulations, standards and good practices related to financial risk management, and cooperate with regulatory, supervisory and supervisory authorities.

The main steps for managing financial risks

The process of managing any financial risk includes a series of measures that ensure that the impact of these risks on business and investments is minimized. Here are the most important steps:

Setting goals

This is the first and essential step in the process of managing these risks. Any entity must determine its strategic, operational and financial objectives, as well as its level of risk tolerance. Goals can be specific, measurable, realistic, and coordinated with the organization’s vision and mission. For example, if an entity aims to achieve high and sustainable market growth, it may be willing to take higher risks than another entity aiming to maintain its stability and liquidity.

Hazard identification

That is, identifying potential risks that may affect the achievement of the business objectives, and analyzing their sources, causes, effects, and likelihood of their occurrence. Risks can be classified according to their source (internal or external), nature (financial or non-financial), impact (positive or negative), frequency (low or high), and predictability (low or high). For example, if a company invests in emerging markets, it may face risks associated with political, economic, legal and social fluctuations in those countries.

Different tools can be used to identify risks, such as scenario analysis, sensitivity analysis, network analysis, and SWOT Analysis.

Risk assessment

Here, the organization must evaluate these risks in terms of their likelihood of occurrence and their impact on objectives. For example, if an entity faces high risks such as a market collapse, project failure, or rising interest rates, it may need to immediately and decisively avoid, reduce, or shift these risks. The business must determine the acceptable, desirable and feasible level of risk.

Quantitative, qualitative, or mixed methods can be used to assess risk, such as matrices, curves, indicators, and models.

Develop a risk management strategy

That is, choosing the appropriate strategy to deal with these risks. For example, the business can take one of the following four decisions:

Risk avoidance: that is, abandoning the activity or opportunity that this risk entails.
Risk mitigation: Taking action to reduce the likelihood of a risk occurring or mitigate its impact.
Transfer of risk: that is, transferring part of the responsibility for the risk – or all of it – to another party, such as insurance, contracts, or partnerships.
Risk Acceptance: Continuing an activity or opportunity despite the risk, while being prepared to face the consequences.

This step helps identify the tools, techniques, resources and responsibilities required to implement the strategy. For example, if an entity wants to reduce the risk of changes in exchange rates, it may use forward contracts to lock in a specific currency rate.

Strategy implementation

Here the chosen strategy is implemented in accordance with policies, procedures, standards and good practices related to financial risk management. This step helps achieve financial, strategic and operational goals. For example, if an entity uses futures contracts to hedge the risk of changes in commodity prices, it may need to enter into, implement and settle these contracts with relevant parties.

Monitor risk and performance

That is, monitoring and following up on the performance of the strategy used to address risks, evaluating its effectiveness and efficiency, and making the necessary adjustments and improvements. The business must collect and analyze data and information related to risks and performance, use key performance indicators (KPIs), reports and reviews, and compare actual results with established goals. For example, if an entity uses key performance indicators to measure and monitor the level of risks and returns in its portfolio, it may need to collect, analyze and present financial data and reports on a regular basis.

Improve the strategy (if necessary)

Based on monitoring, evaluation, and learning from experiences and lessons learned, the business must improve the strategy used to address financial risks by enhancing strengths, addressing weaknesses and threats, and benefiting from learning and innovation.

What role does lending play in mitigating financial risks for enterprises?

Since its establishment in 2016, Al Raedah has become the main financing company for small and medium enterprises in the Kingdom of Saudi Arabia. This is because it enables companies including small and medium enterprises to grow and achieve their business aspirations by providing cash liquidity and appropriate financial solutions that reflect positively on their business, with financial products and solutions that comply with Islamic Sharia controls.

As the owner of an establishment or entrepreneurial project, you can choose the most appropriate financing solution from a group of solutions to finance your commercial project, and the payment method that best suits you. Al Raedah Finance is distinguished by its speed and high flexibility in credit studies and in the method of financing repayment. This guarantees you a great financing experience.

Conclusion

Financial risk management is concerned with applying a set of skills, tools and techniques that play a decisive role in achieving success and sustainability in the work of businesses and organizations of all sizes, ensuring the achievement of the strategic goals of the owners, the smooth running of their daily operations, and achieving the desired profitability. Due to the financing services provided by Al Raedah, the company stands out as the best provider of financing companies and establishments in the Kingdom of Saudi Arabia.

As a business owner, you can obtain financing that meets your aspirations in the best possible way. So what are you waiting for? Find out how Al Raedah can help you; Apply now.

Financial risk management: What is it, and how do you manage risk in business?