How Risk Affects Corporate Financial Strategy

How Risk Affects Corporate Financial Strategy

Financial strategy is a practice that a corporate or a business implements to pursue its objectives. The corporate delegates the top leadership with the task of formulating a financial strategy. An adequate financial plan helps in the smooth running of the business and the achievement of both short-term and long-term goals. In order to experience success, it is important for businesses to manage different types of risks (Shechtman, 2004). The notable risks that affect the financial strategy adopted by an organization include credit, reinvestment, political, and default risk.

A corporate may opt to borrow extra credit from banks or other financial bodies. The credit borrowed has to be repaid after an agreed period. An corporate faces serious consequences it fails pays its obligated debts. To reduce the businesses credit risk, it is advisable that the business checks the prospective lenders, or seeks credit guarantees besides any other strategies.Interest rates of financial institutions and firms that own important interest bearing assets vary from time to time. The business should also analyze the risks because higher risks will mean higher interest rates (Reuvid, 2005). These firms often focus on the strategies of reducing the amount of interest rate risks to increase the number of firms and individuals taking loans. Before any business firm takes a loan, it is relevant for it to analyze the interest rates and ensure that it is favorable for the business.Proper financial strategies are a major asset for a business in order to borrow loans at low interest rates. Businesses incur political risks in two major ways. First, if a business is running in a foreign country, political instability may occur. In this case, the government may chase away international investors and take away the business assets. The second risk is political regulation environment such that the government may hinder the existence of other businesses. A valid example is the sale of pork in Muslim dominated countries.Although there may be a few potential buyers, the government does not allow the sale of such a commodity. Default risk is a situation where a company is unable to make the required payments on the debts obligated. When businesses face to default risks corporate strategies get compromised in all forms of credit extensions. To reduce the impact of default risk, businesses should ensure that the lenders often charge return rates that directly correspond to the debtors’ level of default risk. Reinvestment risk is the chance that a business or a corporate has to be able to reinvest cash flow from an investment at a rate that is equal to the investments current rate of return (Reuvid, 2005). Reinvestment risk occurs when the ability of businesses to reinvest coupons payments falls since the probability of losing the coupons in the first place is high. A business should put in place financial strategies that enable it to invest in bond investing since investing in bonds does not entail the generation of cash flow (Shechtman, 2004). A business that invests where there is a lot of cash flow exposes itself to risks. Reduction of reinvestment risks occurs by investing in non-callable securities that keep the issuing companies from calling away extremely high coupons investment when the market rates are not favorable and fails.

Reference

Reuvid, J. (2005). Managing business risk a practical guide to protecting your business (2nd ed.). London: Kogan Page.

Shechtman, M. R. (2004). Working without a net: how to survive & thrive in today’s high risk business world. Englewood Cliffs, N.J.: Prentice Hall.