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Risk (Finance)

Finance is a professional field dedicated to the analysis, management, and planning of financial strategy, transactions, and record. Financial professionals are accredited fiduciary practice leaders qualified to oversee the financial strategy of an organization, partnership, estate or trust fund, and its portfolio of accounts. Demonstration of higher mathematics competency is required of students studying toward a degree in finance. Finance degrees programs typically demand students perform calculus of financial statements (i.e. ratios) and market activity. Students may study the regulation of financial practices and transactions, as well as rules for stock market exchange laid forth by national and intra-jurisdictional bodies responsible for the oversight of investment agreements and trade. 24HourAnswers is responsive to the needs of students training for a degree in finance. Our team of highly qualified tutors are subject matter experts with the knowledge to assist students in meeting their finance coursework and credential objectives.

Here are some insights from the field of Finance on the topic of Financial Risk:

Finance is a professional field dedicated to the analysis, management, and planning of financial strategy, transactions, and record. Financial professionals are credentialed fiduciary practice leaders qualified to oversee the financial strategy of an organization, partnership, estate or trust fund, and its portfolio of accounts. Demonstration of higher mathematics competency is required of students studying toward a degree in finance. Finance degrees programs typically demand students perform calculus of financial statements (i.e. ratios) and market activity. Students may study the regulation of financial practices and transactions, as well as rules for stock market exchange laid forth by national and intra-jurisdictional bodies responsible for the oversight of investment agreements and trade. 24HourAnswers is responsive to the needs of students training for a degree in finance. Our team of highly qualified tutors are qualified subject matter experts with the knowledge to assist students in meeting their finance coursework and credential objectives.

Here are some insights from the field of Finance on the topic of Financial Risk:

The International Financial Reporting Standards (IFRS) and U.S. GAAP accounting standards require the financial reporting of segment data. Financial analysts apply financial ratio analysis to assess the risk/return profile of an operating segment accounting for 10 percent or more of a company's revenues or total assets. Differentiation of risk profiles by way of ratio analyses of profit margins, ROA and other profitability measures, gives insight into the relationship of an operating segment to the overall financial performance of a company.

In simple terms, risk is measured by standard deviation or shortfall risk estimation of probability. Statistical risk measurement is determined by standard deviation from the mean in a histogram or bell-shaped curve. One example of this mathematical technique is the use of Monte Carlo Analysis applied to casino and stock market exchange predictions of the outcome of a play or trade.

Financial risk analysis is a Time Value of Money (TVM) technique used to determine estimated return on investment. In Finance, the concept of risk is covered in estimation of TVM interest rates (i.e. Real risk-free rate and Default risk premium), as well as capital structure analysis of firms marketed for investment.

A company’s risk profile is defined by the results of a capital structure analysis performed by a financial analyst responsible for estimating performance. Financial ratio analysis performed for this purpose is defined by two classifications: 1) Business risk analysis projecting the company’s income variance over time, and 2) Financial risk analysis evaluating its capital structure (i.e. debt).

Business Risk Ratios

The risk ratios contributing to the business risk calculus within an investment analysis, are performance measures of business development and sales, as well as adjustments to its fixed and variable costs. The fixed-cost structure of a company and its contribution margin ratio (i.e. incremental profits) are the key to estimation of business risk.

Contribution margin ratio = contribution sales = 1 – (variable cost/sales)

Analysis of a company’s operation leverage effect (OLE) estimates the percentage of change to income and return on assets per the percentage of change in sales or, OLE = contribution margin ratio, and the return on sales equals the return on assets (ROA).

OLE is >1 where OLE exists, and ROS = % change in income (ROA) = OLE x % change in sales

Risk estimation of a company’s leveraged debt and financing of operations or financial leverage effect (FLE) calculates the return on shareholder investment and the additional business risk associated with fluctuations in revenues. The FLE quantifies the effect of debt leverage at present.

FLE = operating income/net income

The total leverage effect (TLE) is the combined OLE and FLE exhibiting the multiplier of net income increase by sales increase, or TLE = OLE x FLE.

Analysis of earnings before interest and taxes (EBIT) is used to estimate changes to sales and operating income over time. Statistical analysis of the equation calculates the coefficient of variation to attain EBIT:

Overall business risk = standard deviation of operating income / mean of operating income
Sales variance = standard deviation of sales / sales mean

Financial Risk Ratios

Financial risk ratios estimate the liquidity, profitability, solvency and valuation of a company and its capital structure before it is marketed for fundraising and investment. Financial analysis of a company's debt-to-capital ratio estimates the risk of total debt to total capital.

Debt to capital = total debt/total capital

Where:

Total debt = current debt + long term debt

Total capital = total debt + shareholder equity

The debt-to-equity ratio is estimated by

Debt to equity = total debt/total equity

Capital structure analysis also covers the risk of financing agreements. The degree of protection available to creditors is a key factor. Times interest earned or the interest coverage ratio measures a company’s ability to pay interest payments on an installment agreement.

Interest coverage ratio = earnings prior to interest and tax/interest expense

Fixed-charge coverage estimation of contractual committed periodic interest and principal payments, provides the total sum of leases and debt. 
Fixed-charge coverage = earnings prior to fixed charges and taxes/fixed charges

The cash basis of a company’s accounts is calculated with times earned interest adjustment to its operating cash flow from operations, fixed charges, and tax payments.

Times interest earned – cash basis = adjusted operating cash flow/interest expense

The capital expenditure ratio provides the sum of cash generated from operations after capital expenditures for servicing a company's debt have been paid.  The ratio provides the total required reinvestment for operations as well as service of the debt itself.

Capital expenditure ratio = cash flow from operations/capital expenditures

Finally, the estimate of cash from operations available to pay off total debt, including interest-bearing, short-term and long-term debt.

Cash from operations to debt = cash flow from operations/total debt

Students studying toward a degree in Accounting, Finance, or Investment Management learn how to perform business risk analysis and financial risk analysis for the purposes of account management and reporting.

To fulfill our tutoring mission of online education, our college homework help and online tutoring centers are standing by 24/7, ready to assist college students who need homework help with all aspects of finance, including risk. Our finance tutors can help with all your projects, large or small, and we challenge you to find better finance tutoring anywhere.

Bibliography

“Analyze investments quickly with ratios.” Investopedia. 

Busser, Gary, “For the Investor: Segment Reporting.” Financial Accounting Standards Board (FASB).

International Financial Reporting Standards. (IFRS) 

“Ratio Analysis: Comparisons between the financial information in the financial statements of a business.” Corporate Financial Institute. 

 

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