How does risk affect a company’s financial decisions?
Risk refers to the probability that return on investment is likely to be lower than the return expected. Risk affects a company’s financial decisions on whether to pursue a certain investment or not by assessing the risk impact. Risk analysis also enables companies to assess potential bottlenecks that could affect their investment (Adams, 1974).
What risks should a CFO consider in making a decision? Name at least five and describe each.
In assessing risk, a Chief Financial Officer should consider the following types of risk. They include business risk, exchange rate risk, purchasing power risk, financial risk, interest rate risk, and tax risk, among others. The following are brief explanations that expound on what these risks are. First, business risk refers to changes in operating income over a given period of time that arise as a result of changes in unit sales, mark up on sales, and/or fixed expenses. Second, exchange rate risk is associated with risk that arises as a result of the effect of the variations of the U.S. dollar on revenues and expenses. Third, purchasing power risk refers to the risk that arises as a result of changes in inflation that affect profitability, revenue, and expenses. Fourth, financial risk refers to changes in income before taxes over a period of time. This is because fixed interest expenses do not in any way vary as a result of an increase or decrease in operating income. Fifth, interest rate risk refers to changes in interest expenses that are not in any way related to operating income nor sales. Lastly is the tax risk. This refers to variations in a firm’s tax rates and tax-related charges across a given time frame due to the changing nature of tax laws and regulations (Dowd, 2008).
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References
Adams, J. R. (1974). Risk taking and the decision making process. Project Management Quarterly , pp. 20-25. Retrieved from https://www.pmi.org/learning/library/risk-taking-decision-making-process-1971
Dowd, M. W. (2008). Financial RiskManagement forManagementAccountants. Retrieved from CIMA: https://www.cimaglobal.com/Documents/ImportedDocuments/cid_mag_financial_risk_jan09.pdf
