Description
If you were a finance leader in a business organization, how would you apply the concept of risk and return in your daily decision-making processes? How might you explain the concept of risk vs. return trade-off during a shareholders’ meeting? How would a proposed initiative to diversify current holdings factor into the discussion about total risk for the organization? Explain.
As a financial manager, I am interested in managing an entity’s finances and ensuring that its resources are utilized to generate the highest profit while minimizing risk. I want to ensure that the company’s profits on its investments and projects more than pay for the risks it assumes. Thus, the corporation can maximize its profits and shareholder returns.
Business risk is frequently divided into two categories: systematic risk and unsystematic risk. Systematic risk refers to the general amount of risk associated with any firm, the fundamental risk caused by changeable economic, political, and market factors (Maverick, 2021). Systematic risk is an inherent business risk over which businesses typically have little control, other than their capacity to predict and respond to changing situations (Maverick, 2021).
Unsystematic risk, on the other hand, refers to the hazards associated with a company’s particular line of business. Good management decisions concerning costs, expenses, investments, and marketing can help a business lower its level of unsystematic risk (Maverick, 2021). Unsystematic risk can be reduced through diversification. Investors will be less affected by single occurrences if they have a diverse portfolio of firm stocks across industries, as well as other types of assets in several asset classes, such as Treasuries and municipal securities (Maverick, 2021).
As a financial manager, I would note that the same idea applies to the business. Having numerous projects and investments reduces risk, as the failure of one will not bring the business down as long as others remain successful. Gains and losses from each project and investment will cancel each other out. Typically, shareholders seek profits consistent with the risks associated with their investments. They want to understand the risks a firm faces, the severity of those risks, and what the company is doing to lessen them. Diversification is a risk management approach for mitigating this uncertainty.
References
Maverick, J. B. (2021, July 25). Financial risk vs. Business risk: Understanding the difference. Investopedia. https://www.investopedia.com/ask/answers/062315/what-are-key-differences-between-financial-risk-and-business-risk-company.asp
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