Question

Explain the meaning of the terms business risk and financial risk.

Answer 1

Business risk involves systematic , unsystematic( industry related risk), operational risk, foreign exchange risks and other risks which hampers the net profit margin, operating profit margin and the profitability of the business. Risky business but opt low debt to equity ratio. But in pursuit for aggressive strategy many firms opt for high debt to equity ratio which puts them under tremendous risk during downturn.

Financial risk the risk involved in a company which is overleveraged (high debt to equity ratio). This creates a risk for equity holders as on liquidation the first preference is given to debt holders as compared to equity holders. Risks include liquidity risk, credit risk, etc.

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