Business Risk vs. Financial RiskDifferences You Need to Know Between the Two!

Denise Elizabeth P
Senior Financial Editor & Contributor

Date Published: August 4, 2022

Differences Between Business Risk and Financial Risk

Business Risk can be referred to as systematic risk, an uncontrollable risk that may affect the day-to-day operations of a company.

Examples of these risks are market risk: higher commodity prices, fluctuation of stock prices or foreign exchange rates, etc.

It is an inherent risk that may subject a business operation to incurring unexpected losses.

Whereas, Financial Risk deals with the financial aspect of the business.

The most common risks include Liquidity risk, the inability of the company to pay its short-term obligations on time.

Solvency risk is the risk that a company will not be able to pay its long-term debt even after the sale of its assets.

Business Risk

You cannot do business without the risk involved in it.

Business is all about taking risks, and it is in how the management crafts the business plan and risk management strategy that risks are mitigated.

The measurement of a well-planned business strategy is by being able to generate profit from its day-to-day operations.

Financial Risk

Financial risk is the inability of the company to pay either its short-term or long-term debt on time.

To lessen the financial risk, a company can improve equity financing.

When a firm incurs debt, the proceeds are utilized to acquire an asset expecting that economic returns will flow to the company.

However, this may not always be the case because there will always be an underlying financial risk to every debt incurred.

financial risk

Key Differences

  • Business risk arises when the net profit of the firm is not achieved because of the inability of the company to cover day-to-day business expenses. Financial risk arises when a firm takes on debt and may be unable to pay it. 
  • Business risks are inherent risks, which means that it naturally comes with running a business. Financial risk is a controllable risk that can be eliminated by financial leverage. A lower debt-to-equity ratio can increase a company’s equity earnings.
  • Types of business risks are operational, reputational, strategic risk, etc. Financial risks are liquidity risk, credit risk, equity risk, etc.
  • Business risk is measured by computing a firm’s Earnings Before Interests and Taxes (EBIT). While the calculation of financial risk is by computing a firm’s financial leverage multiplier.
  • Business risk is correlated to a business’s day-to-day operations. Financial risk is correlated to a business’s capital structure.

Comparative Table

Basis for ComparisonBusiness RiskFinancial Risk
MeaningBusiness risk is the risk of generating inadequate profit to cover business expenses.Financial risk is the risk that a company will not be able to pay its short-term or long-term debt on time.
What it is AboutBusiness risk deals with the day-to-day operations.Financial risk deals with the payment of debts.
Is it Avoidable?No. It is inherent in doing business.Yes. Without incurring debt, the firm will not be subject to financial risk.
DurationIt exists for as long as the business operates.Until there is a generated return on the investment.
Why do these risks occur?As businesses operate, they will face different types of risks. It may be internally or externally.Debts can also be used to increase the returns of the firm.
How a firm can handle itUse different cost-benefit analyses. A company may also use a cost minimization strategy or a profit maximization strategy.Minimize incurring debt, and focus more on equity financing by finding more investors.
MeasurementChanges in EBIT.By calculating the financial leverage multiplier or measuring the debt-to-asset ratio.

Conclusion

Business and financial risks are the two most addressed risks in a business.

The company may experience both risks simultaneously.

Eliminating business risk is impossible to do so because as long as the business operates, business risks also exist.

In the same way, firms can use debts to expand business operations which will present financial risks. 

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  1. Purdue "Balancing Business and Financial Risk" Page 1 . August 4, 2022

  2. University of Kansas "Risky Business: Examining 3 Common Business Risk Types" Page 1 . August 4, 2022