It might happen that the actual results of the business diverts from the planned structure, leading to financial deviation in measurements. When the actual results match with the forecast there is a profit whereas when there is a mismatch it leads to a loss. So at the very outset it is known that the forecasts may not materialize. This is known as risk. The possibility of risk arises when there is an uncertainty regarding the outcome of an event. Suppose, a US based company wants to set up its operations in UK. For this it has to set up a new unit in UK, buy equipments, employ new staff etc. All this requires funds. This can be obtained as loans from financial institutions. But the loan comes at a cost which is the rate of interest that the company has to pay on the amount raised. This exposes the company to interest rate risk. If the rate of interest rises, the interest burden of the company increases putting a strain on the earnings.
A new investment has to face the risk of market competition. The existing competitors may have a strong market reputation. This will make it difficult to penetrate the market. If the company’s product is not accepted by the customers this might result in loss of huge revenues. It is important that the management has proper strategies in place to counter this risk.
The company accepts a project based on an anticipation of future cash inflows. But there remains an uncertainty about the generation of the future cash flows. If an organization sells goods on credit, there is a possibility of non-payment by the debtors. This will impact the profitability of the project. To ensure that the non-payment does not affect the project performance the company must take the requisite steps.
The overseas operations of the company give rise to foreign currency receivables and payables. It has to pay for the purchase of raw material, equipments and other costs in the foreign