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Financial risk generally comes from one of three places: market instability, financial transactions, and organizational failures. Managing financial risk usually relies on either reducing the chances of incurring financial losses or minimizing the financial losses that happen as a result of a financial risk. Generally, this involves planning operations to increase safety and efficiency, keeping on top of financial records, and purchasing insurance or other means of offsetting necessary financial risk. Overall, the most important part of managing financial risk is to know as much about the risk as possible before exposing an organization to a financial risk.
Market instability, or changes in the environment in which an organization conducts its business, can come from many sources. It can include change in the market price of goods, changes in competition within a market, and changes in the political climate in which the company operates. Financial transactions occur any time money changes hands, whether it is during a sale, a bank transaction, or in the payroll process. Organizational failures can be mechanical failures, failures in management, or failure of an employee to perform his duties. All of these things can cause losses that influence the overall profitability or success in a company.
The most basic part of managing financial risk is identifying the financial risks faced by a business. It is also important for an organization to know how much risk it can take without creating intolerable financial hardships for the company. Based on this information, a company can develop a strategy for managing financial risk. Once a strategy has been designed an implemented, an organization must then monitor and measure the outcome of the financial risk management plan. A company can use information gathered by monitoring the outcome of a financial management plan to make changes to improve its effectiveness in managing financial risk.
The end goal of managing financial risk is to reduce losses by preventing them. Some losses a business might face can be reduced by insuring the company. Losses of this type can include fire, flood, and theft. Taking steps to reduce loss in a company as a result of theft is called loss prevention. Steps to prevent loss from theft can include surveillance, on-site security, and advanced cash management procedures.
In investment, one way of reducing loss is diversification. Diversification is the practice of having more than one type of investment, so if one investment type or market suffers serious losses, the investor will not lose his entire portfolio. One example of this might be investing in oil and bio-diesel fuel. In the event that one fuel method suffers market losses, another will likely prevail in its place.