Differences Between Business Risk vs Financial Risk
Business Risk vs Financial Risk – Business is another name of the risk. But all risks are not similar. To run a business, the owners of the company has to deal with quite a lot of risks. Business risk and financial risk are two, most significant ones.
Business risk can be defined as the risk that whether the owner/s of the company would be able to run the business or not. We can call it a risk relating to operations and whether the company would be able to make profits or not.
Financial risk, on the other hand, can be defined as the risk of not being able to pay off the debt. When a firm wants to improve its financial leverage by allowing debt to enter into their capital structure, they suffer from financial risk. Financial risk is directly proportional to how much debt you allow into your capital structure.
In this article, we will talk a comparative analysis of business risk and financial risk. Let’s get started with the head to head differences and then we will talk about each of these risks separately.
Business Risk vs Financial Risk Infographics
There are many differences between financial risk vs business risk. Here are the top ones that stand out –
Business Risk vs Financial Risk – Key differences
There are many differences between business risk vs financial risk. Here are the key ones that stand out –
- Business risk can be defined as the risk associated with not being able to earn enough to pay off the expenses of the business. On the other hand, financial risk can be defined as the risk associated with not being able to pay off the debt the firm takes to create financial leverage.
- Business risk can never be nil. It would always be there as long as the business exists. Financial risk can be pared down to a bare minimum if the debt can be reduced and equity can be increased in a capital structure.
- Business risk includes risks like reputational risk, operational risk, strategic risk etc. Financial risk includes risks like credit risk, liquidity risk, equity risk etc.
- Business risk can be measured by the variability in EBIT (as per situation). Financial risk can be measured by financial leverage multiplier.
- Business risk is related to operations of the business. Financial risk is related to the capital structure of the business.
Business Risk vs Financial Risk (Comparison Table)
|The basis for Comparison between Financial Risk vs Business Risk||Business Risk||Financial Risk|
|1. Meaning||Business risk is the risk of not being able to make the operations profitable so that the company can meet its expenses easily.||Financial risk is the risk of not being able to pay off the debt that the company has taken to get the financial leverage.|
|2. What it’s all about?||Business risk is purely operational.||Financial risk is related to the payment of debt.|
|3. Avoidable?||No.||Yes. If the firm doesn’t take debt, there would be no financial risk.|
|4. Duration||Business risk will be there as long as the company operates.||Financial risk would be there until the equity financing is increased drastically.|
|5. Why?||Every business wants to perpetuate and expand; and with continuation comes the risk of not being able to do it.||To generate better returns and to tap into the lure of financial leverage, company gets into debt and takes the financial risk.|
|6. How to handle it?||By systemizing the process of production and operation and by minimizing cost of production/operation.||By reducing debt financing and by increasing equity financing.|
|7. Measurement||When there’s variability in EBIT.||We can look at the debt-asset ratio, and financial leverage multiplier.|
Business risk and financial risk can happen together, but for separate reasons.
Business risk, as you already understood can’t be wiped off still business exists. But financial risk can be wiped off completely if the business doesn’t take any debt while constructing their capital structure.
The wisest decision is to systemize the process so that the business risk can be pared down. And the capital structure also needs to be constructed in such a way that the portion of debt is enough to enable financial leverage, but not so much to increase financial risk.
This has a been a guide to the top differences between Business risk vs Financial Risk. Here we also discuss the Business Risk and Financial Risk differences with examples, infographics, and comparison table. You may also have a look at the following articles for gaining further knowledge in corporate finance –
- Financial Leverage vs Operating Leverage – Which is Best?
- Unsystematic Risk vs systematic risk
- Equity vs Debt
- Solvency vs Liquidity
- Leverage Ratios Examples