Types of Risk 5 / 6

Let's look at 3 commonly examined types of Risk

Business Risk

comes from the nature of a company’s business operations

  1. The variability of returns due to business operations

  2. The way operating profit changes as revenue changes

  3. Looks at operational gearing

    How much variable compared to fixed costs the business has

  4. Can be calculated as (Sales - variable costs) / Operating profit

    Then shown as a %

Financial Risk

Looks at the amount of debt as a source of finance

  1. The variability of returns due to having to pay interest

  2. Debt/equity ratio - using either book or market values

  3. Interest cover also - PBIT / Interest

Systematic Risk

the sum of business risk and financial risk (to the shareholder)

  1. The risk relating to the market as a whole (individual company risk diversified away)

  2. Also known as Market risk and Undiversifiable risk

  3. Can be assessed by the equity beta of the company (which includes both finance and business risks)

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