Advantages & Disadvantages of Financial Risks Within Companies
Companies take on financial risks in the hope of obtaining financial rewards. Taking risks is essential in business, as it is the driver of growth and profitability. However, different types of financial risks present distinct advantages and disadvantages, making each more or less appropriate at different times. Understanding the advantages and disadvantages of financial risks within companies is a starting point for determining which risks to take and when.
Companies take a financial risk every time they invest in capital equipment, which includes such things as machinery, vehicles and buildings. Capital investments can provide the advantage of increasing output or lowering operating costs, which in turn can boost profitability and net income. However, they have the disadvantage of incurring large cash expenses or boosting debt balances, which can squeeze cash flow or negatively impact debt ratios. Purchase used equipment, take advantage of cash discounts, and negotiate prices and payment terms to lessen the impact of these disadvantages. Consider leasing equipment to further mitigate the risk of depreciating asset values.
Debt and credit provide the advantage of immediately increased assets on the books, whether in cash or other assets. Interest payments on debt are tax-deductible in most instances, providing the benefit of reducing taxable business income. On the other hand, taking on debt has the disadvantage of increasing short- and long-term liabilities, which can dampen cash flow and ratio valuations. Debt can be necessary to fund growth strategies or fill large, unexpected orders, but it can damage company finances if used excessively. Analyze your business credit report and debt ratios regularly to keep debt levels consistent with industry averages. This will allow you to maximize the utility of your debt by using as much as you can without harming your credit reputation.
Increasing the number of employees in an organization can incur significant and ongoing financial obligations. As with debt and capital investments, companies boost their payrolls in expectation of or response to increased demand. Hiring new employees has the advantage of providing additional human resources to spread among new outlets, assign to expanding company responsibilities and serve additional customers. The major disadvantage of workforce growth is the human element of the investment. If growth plans do not pan out or demand increases prove temporary, company owners can find themselves in an ethical dilemma as they decide how trim the additional labor expenses. Use interns, contractors, seasonal workers and temporary employees to cover short-term increases in demand to avoid the necessity of future layoffs, and hire employees steadily rather than rapidly as part of long-term growth plans.
Seeking investment from venture capitalists, angel investors or stockholders presents its own set of risks and potential rewards. The ability to raise debt-free capital and benefit from the experience and connections of investors are major benefits of outside investment, but at the cost of diluted company ownership and managerial control. Furthermore, private companies choosing to go public by selling shares of stock on the open market run the risk of all managerial control being taken from company founders. Consult with a mentor or trusted investment banker about the pros and cons of outside investment for your business before pursuing this option.