Financial analysis tools 101: Here’s how a risk analysis works
The financial analysis tools you can use to analyse your financial statements fall into three categories:
• Profitability analysis;
• Return on investment analysis; and
• Risk analysis.
For the purposes of this article, we’ll focus on the risk analysis because it’s often misunderstood by business owners.
Read on to find out how it works so you can analyse your company’s financial statements properly.
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Here’s what you need to know about a risk analysis
The Practical Accountancy Loose Leaf Service explains that to a business owner or investor, capital invested into a business is always at risk. It may have declined due to poor results of the business or worse, it may eventually be lost completely because the business goes into liquidation. It’s therefore important to monitor the level of risks that a business faces.
Risk analysis basically attempts to quantify the level of risk your business has. If you don’t analyse risks in your business, you won’t be able to monitor them and may eventually lose invested capital because of this.
What you need to know is there are two groups of risk analysis. They are: Capital structuring risk analysis and liquidity risk.
According to the business dictionary, liquidity risk refers to the probability of loss arising from a situation where:
- There will not be enough cash and/or cash equivalents to meet the needs of depositors and borrowers;
- The sale of illiquid assets will yield less than their fair value; or
- Illiquid assets will not be sold at the desired time due to lack of buyers.
Capital structuring risk analysis on the other hand looks at the level of debt your business has.
There you have it. Knowing how a risk analysis works will help ensure you analyse your company’s financial statements properly.
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