Resources for Developing a Financial Plan/Risk Assessment and Risk Management

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Globe for WikiEducator.jpg Unit 6.1-Resources for Developing a Financial Plan 

Introduction | A Financial Plan | Presentation and Customization | Risk Assessment and Management | How Do I Qualify? | Summary | Resources | Activities | Assessment

Risk Assessment and Risk Management

Commercial risk is the risk associated with the individual companies of the buyer and the seller. Information is often the key to managing this risk. A previous lesson explored the preparation of this type of information. Now it is important to be able to read and assess the information gathered.

Commercial Risk

Commercial risk can be evaluated with the assistance of the following:

  • Credit bureaus can provide credit checks, which are mostly effective in industrialized countries. In developing countries, most of the usual financial information is missing and is often more like a reference.
  • Foreign credit insurance providers will approve and assume the credit risk, eliminating the need for heavy investigation.
  • Banks can request a credit check from a prospective client’s bank. This information is generally limited to the length of time they have been a client of the bank, whether they have a credit facility, and whether they are in good standing. It does not provide information on how they pay their bills.
  • U.S. Department of Commerce – Commercial services can provide contacts with commercial officers located overseas for country analysis. The information provided is generally broad in nature, not specific enough for individual company evaluations.

Balance Sheet Assessment

The review and understanding of the following will help a company evaluate its standing as well as that of any other prospective company.

Liquidity is the ability of a company to pay its bills as they come due. The higher the number, the greater the liquidity.

Current Ratio = Current assets
Current liabilities
Quick Ratio = Current assets - inventory
Current liabilities

Another key ratio to determine how quickly a company collects on its outstanding receivables is to use the accounts receivable turnover to determine the average collection period.

Accounts receivable turnover = Total sales
Accounts receivable balance
Average collection period = 365 days
Accounts receivable turnover

Leverage is the use of debt to finance the company’s assets. Banks often use a debt to equity ratio to determine if a company can support the requested debt. The higher the ratio, the greater the risk is; if the risk is too high, the company may have to seek a secondary lender such as a factor or a private finance company.

Debt to equity ratio = Total debt
Total equity

Profitability is important for bill paying and debt servicing. It is also a key factor in determining a return on investment. Comparing the return on assets ratio to other alternative investments provides an objective comparison and evaluates risk with greater precision.

Return on assets = Net Income
X Sales
Total Assets
(Profitability of sales) (Asset efficiency)

Country risk

Country risk assessment is a key component in the decision- making process when considering funding. Countries are evaluated based on key elements and stability. Companies consider both political and economic factors when making country risk forecasts, because economic hardship and political unrest are closely related.

Political factors that come into play are the frequency of coups, labor unrest, the attitudes toward capitalism, nationalistic tendencies rather than democratic policies, protectionism, movements toward expropriation, the military role in government, political factions within the country, and social and ethnic conflicts.

Economic factors that come into play are inflation rates, unemployment rates, the gross domestic product, fiscal deficits, the availability of natural resources, the balance of trade, the international reserve position and the proportion of the nation’s export earnings needed to service its external debt.

Currency exchange is an economic factor of a country which can have a significant impact on those trading with that country. Not all governments allow their currencies to float freely. The private sector has found many ways to circumvent government in order to trade for desired products. Both political and economic factors will impact the fluctuation of a currency. It is important to monitor and often hedge against this volatility.