External & Internal Factors of Financial Risk

Financial risk refers to the risks that businesses run when making investments, planning for the future and conducting day-to-day operations. All businesses run some risk in making financial decisions. Some of these risks are external, depending on outside factors and decisions made by other organizations and consumers. Other risks are internal and deal with the chance that the strategies and actions the business leaders choose may have negative effects on operations.

Market rates are one of the most pervasive types of external factors when it comes to financial risk. The market changes based on consumer interest, supply and demand and new elements like technology. When the economy speeds up or slows down, interest rates for bonds and loans change. These changing rates can make it more expensive for a business to get a loan, or require it to make higher payments on bonds it uses to generate capital.

Government regulation is another important factor in all financial planning. Governments create tariffs (or taxes on imports and exports), changing existing tax laws and put new financial regulations into place constantly. Some changes are beneficial, such as creating tax deductions for certain business actions. Others can make it more difficult for a business to make a profit, such as lowering treasury bond rates and adding new requirements to tax reports.

Credit is halfway between being an external and internal factor. In many ways, business credit is an external factor of risk, because it depends on what outside lenders are willing to loan, and the rates or requirements lenders choose for the business. On the other hand, credit depends on the past decisions the business has made, what lenders it approaches and its current financial position -- internal factors.

Liquidity is simply how easy it is for a business to turn securities into cash. Cash is the most liquid type of fund, but it also makes the least amount of money. Businesses must balance how much cash they hold for emergencies with less liquid securities like bonds or shares.

Cash flow refers to the daily revenues and expenses of the business. This is an internal factor of risk that depends on what expenses a business choose to pay and how much revenue is directed to specific areas of the business.