Risks & Uncertainties in International Finance08/09/2022 0 By indiafreenotes
Risk and uncertainty are often used interchangeably in financial management literature. However, there are differences between the two and they represent strictly different ideologies. In this brief article, we will highlight the points that differentiate these two terms, risk and uncertainty, when they are used in Finance parlance.
Risk is the process of potential loss for a firm. The concept of risk is broad in finance. In finance, the risk is associated with a bad outcome occurring or a good outcome not occurring at all. For instance,
- If the income falls down below a certain mark, it is a risk for the company.
- If the business grows 10% instead of the projected 20% rate, that is also a kind of risk for the company.
Uncertainty refers to an absence of certainty, that is, there is no guarantee of something happening in the present or the future. There is an absence of a given outcome in uncertainty. Since the outcome of an event is not certain, there is hardly any measure of uncertainty. That is, we cannot measure uncertainty in the business world. It is a process that can just be stated but not measured.
For example, let’s say that a business can earn 10% or 20% of profit within the next two years. However, it is uncertain because we cannot measure it. So, there is a kind of probability attached to uncertainty which is improbable in the case of risk.
Risks & Uncertainties in International Finance
When an organization decides to engage in international financing activities, it takes on additional risk along with the opportunities. The main risks that are associated with businesses engaging in international finance include foreign exchange risk and political risk.
These challenges may sometimes make it difficult for companies to maintain constant and reliable revenue. In this article, we’ll review the strategies companies can employ to reduce the impact of the risks they face from doing business internationally.
Foreign exchange risk occurs when the value of an investment fluctuates due to changes in a currency’s exchange rate. Foreign exchange risk is also known as FX risk, currency risk, and exchange-rate risk. When a domestic currency appreciates against a foreign currency, profit or returns earned in the foreign country will decrease after being exchanged back to the domestic currency. Due to the somewhat volatile nature of the exchange rate, it can be quite difficult to protect against this kind of risk, which can harm sales and revenues.
The risk occurs when a company engages in financial transactions or maintains financial statements in a currency other than where it is headquartered. For example, a company based in Canada that does business in China; i.e., receives financial transactions in Chinese yuan reports its financial statements in Canadian dollars, is exposed to foreign exchange risk.
Uncertainties in International Finance
Uncertainty is one concept in finance and accounting that should be deeply understood. Business owners, as well as investors, want to access credible and honest financial statements during times of uncertainty.
Through generally accepted accounting principles, including those that are from the Financial Accounting Standards Board, there are now processes that can be used to identify, record, and disclose uncertainty. Using accounting principles consistently makes it possible to compare financial records from various periods.
How to Turn Uncertainty into an Advantage
The only thing certain thing about uncertainty is that it can happen anytime, and when it does, no company is exempt from feeling its effects. Therefore, the most effective thing to do is to prepare for it and turn it into an advantage. Here’s how:
- Forecasting is essential
Companies who rely on annual budgets are finding themselves in shallow waters nowadays because the figures may no longer be applicable even before a specific financial year is over. This is why forecasting and updating plans regularly are important.
- Shift to automation
Manual collection of data takes up more time than actually analyzing it, which is why it is often too late when problems are identified. Business organizations should shift to automation because it cuts the time needed for data collection and analysis.
- Efficient reporting of finances
Automation also contributes to achieving financial reports that are efficient and accurate.
- Self-service is key
Stakeholders are an important component of an organization, which is why providing self-service apps is helpful. For example, users can use a specific app that lets them open their accounts and evaluate the data by themselves. This not only gives them the freedom to do so anytime it is convenient for them but it also frees up work for the organization’s IT team, letting them concentrate on more important processes.