How to identify a financial risk
Today let’s find out how to identify a financial risk. This operation is necessary at both the personal and corporate finance. There are several indicators that make it clear whether a risk is higher than another, and then you will have to pay the utmost attention to their interpretation.
First of all you have to calculate the difference between current assets and inventories or liabilities, in relation to long-term investments in equity and debt to total assets. The higher the gap, the greater the financial risk. Examine the three-year budget looking for defects, such as a sharp increase in receivables, which indicates that the company may have drawn the data incorrectly, increasing them on its own. If there is instead a sharp rise in inventories, it will mean that the company is in deficit. Be wary of data that indicate many or excessive increases in loans to shareholders, as it means that it is the same company that will pay off personal debts.
Analyze carefully the statement of cash flows, to have in mind the amount of money that the company receives from year to year. If the operating cash flow is less than that invested, it is a sign that the company’s debt is increasing, which provides a greater financial risk. Also, if you notice that sales have increased, but the cash flow is still negative, it is necessary that you can understand the economic transactions made. Read the notes very well, as they are key indicators of the methods and policies adopted, providing information about pending litigation and on long-term commitments taken which may prove to all potential indicators of financial risk. In fact, companies often use footnotes to keep information that can be seen as weaknesses hidden.
See also the section on management discussions, in which the potential problems related to various financial risks of corporate transactions is examined. Finally, examine the proxy statement, which is a report that is distributed to shareholders urging them to express consensus on issues that require a majority approval. Once you have a overview of all these data, the evaluation will certainly be easier.