What is Financial Risk Analysis?

"Financial risk" refers to the possibility for loss greater than gains in a financial venture. Any financial decision involves a certain amount of financial risk analysis, from choosing between investment options to deciding whether to buy a house. Financial risk analysis involves looking at the given circumstances of a financial decision and trying to determine what the chances are that the venture will cause greater financial harm than good. The outcome of financial risk analysis depends heavily on the individual circumstances; both internal and external factors can significantly contribute to the level of risk.

Often, financial risk analysis is involved in business and investment planning. While a person with a relatively simple investment portfolio may be able to perform rudimentary risk analysis alone, many investors rely on investment managers and market analysts to help prepare risk analysis reports. Some of the factors that may go into a risk analysis for an investment might include the total assets and financial stability of the investor, the performance history of the investment, current economic conditions, and external factors such as wars, environmental problems, or impending legislation that might affect the performance of the investment in the future.

When a person decides to open a new business or invest in a young company, many other factors may be used in financial risk analysis. For instance, if a person wanted to open a restaurant, he or she would have to examine data such as market saturation with similar restaurants, whether there are positive factors in favor of success, such as a celebrity chef, and the size of initial capital versus the time it will take to make the venture a success. Proper risk assessment cannot always predict the future, but it can at least help create success deadlines that let investors know when a venture is becoming a liability instead of a potential success.

Financial risk assessment can also help communities make decisions about expansion or new projects. If a city wished to dam a river to help create more usable land, there would be many financial considerations that would be important to examine. In addition to basic issues, such as the cost of construction versus the selling price for the created plan, the community would need to analyze the potential damages in case of a dam failure, the effect the project would have on water supply and water-related tourism, and the possible environmental costs of altering a natural ecosystem.

In many cases, financial risk analysis is performed through the use of probability formulas and fairly complex mathematical calculations. Not surprisingly, a considerable market has been created for financial risk analysis software, which allows the user to plug in potential risk factors and does the calculations on its own. Still, the help of professional risk management advisers can be invaluable, as many have a deep understanding of their particular area of expertise, and may be able to point out a variety of risk or benefit factors that are easily missed by the casual eye.