Business and financial risk pdf

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Business Risk: An Overview Financial risk and business risk are two different types of warning signs that investors must investigate when considering making an investment. Key Takeaways Financial risk relates to how a company uses its financial leverage and manages its debt load.

Business risk relates to whether a company can make enough in sales and revenue to cover its expenses and turn a profit. With financial risk, there is a concern that a company may default on its debt payments.

With business risk, the concern is that the company will be unable to function as a profitable enterprise. Compare Accounts. In return for the financing, the SPV may be required to pay additional interest or pay a premium on the cost of renting the equipment. RISKS Risk is a crucial factor in project finance since it is responsible for unexpected changes in the ability of the project to repay costs, debt service and dividends to shareholders.

If cash is not sufficient to pay creditors, the project is technically in default. Such risks can arise either during the construction phase, when the project is not yet able to generate cash, or during the operating phase.

One of the reasons that participants employ the project finance model as opposed to traditional finance is because infrastructure projects require large volumes of capital.

With so many participants, risk can be allocated among the parties best able to bear it. Because project finance is a common financing mechanism for long-term, labor-intensive projects, risks are abundant and may surface at any one of the many stages in the project cycle. This next section will discuss the main risks inherent in project finance and how the various parties, in their agreements with each other, attempt to mitigate them.

Financing infrastructure projects, especially in developing countries, entails a formidable set of risks. It is the role of the project finance advisor, the project sponsor and other participants to structure the financing in such a manner that mitigates these risks.

Lenders and investors always are initially concerned about financing immobile assets in distant, politically-risky areas of the world. The purpose of this section is to provide a checklist of the risks that a project finance transaction faces.

Like in traditional finance, changes to the interest rate may negatively affect the financier or the SPV, or both. Most projects are long-term so lenders charge floating rates as opposed to predetermined, set rates based on market conditions.

Therefore, when interest rates rise, the costs of the project will increase and the SPV may find itself unable to meet its financial obligations. Alternatively, the SPV may use interest-rate swaps to mitigate the risk that a floating rate will increase.

The SPV may swap with another party, like a private bank, the floating interest rate for a fixed interest rate on the principal amount the SPV borrowed. Currency risk occurs when revenues are generated in one currency while debts must be repaid in a different currency. This is called currency mismatch. In project finance, financing is typically received in the currency in which the lender operates and the lender expects to receive payment in the same currency—e.

However, because currency exchange rates fluctuate, an SPV may find itself unable to pay its lenders if the domestic currency suddenly and significantly drops in value. For example, fluctuations in exchange rates may make repayment difficult if an SPV generates revenue in the Thai baht, but must pay back in dollars. If the baht drops in value with respect to the dollar, then the SPV will need to come up with more baht to pay back the loan because one baht now pays back less debt then before the devaluation.

Similar to interest rate swamps, the SPV may mitigate risks stemming from currency exchange-rate fluctuations by utilizing a currency swap, allowing the SPV to convert debt into a more stable currency. Also, a real exchange-rate liquidity REX facility may be used, which addresses the risk of a devaluation of the local currency. In the event of a specified devaluation, resulting in a cash flow shortfall, the facility provides liquidity to cover the debt payments.

Essentially, either through poor planning or because of some extraneous event like the Asian Financial Crisis, demand for the project-finance generated goods or service may drop, in which case the essential element of project finance—the revenue stream to pay back loans—is reduced.

A drop in demand was the reason the Pigbilao Project failed in the Philippines. Napocor, the Philippines National Power Company, was the off-take purchaser and bore the demand risk.

When demand fell and prices rose, Napocor feared political backlash and had to subsidize the price of energy. The best method to mitigate demand risks is for the parties to do extensive pre-construction forecasting of future demand.

Additionally, the party bearing the demand risk may seek a guarantee from a third party like the World Bank, as detailed below.

Sponsoring companies often overlook the possibility of a change of authority, yet a regime change or a change in power of a ruling party can influence the success of both the construction and operation of a project. Given the close relationship of the SPV and the host country in project finance, even the possibility of a change can be disruptive to the progress of a site. Government corruption can also seriously hinder a project.

Take for instance the Dabhol power project in India. The sponsoring companies negotiated a rushed agreement with the Indian government, which was anxious to have foreign investment in the region, forming the Dabhol Power Company DPC. In , Dabhol became a major campaign issue in the Maharashtra state election. The two parties won on a platform that advocated hostility to the sponsoring companies of the Dabhol Power Company.

Once in power, the new government created the Munde Committee, which reviewed the Dabhol power project and determined that the Indian government rushed into an agreement with DPC, and that the agreement was too one-sided. As a result, the government ordered DPC to stop construction. After lengthy negotiations, the agreement with India was renegotiated.

While the project did not ultimately fail because of the political change it failed because of miscalculation for demand , the Dabhol power project demonstrates the extent to which a change in power can bring a project to a standstill.

Political risks are mitigated by political risk insurance. Specifically, changes in import and export tariffs can increase costs by preventing access to cheap raw materials or by forcing the SPV to use inferior domestic inputs. A host government may want to achieve certain short-term economic or social goals by changing the tax code, which can purposefully or inadvertently affect the project structure. The rate at which host country taxes the SPV or other parties will significantly affect the financial benefits to participants.

Finally, the host country can adopt laws that change the legal status of the SPV, or change the laws governing ownership of companies or real estate, which can have a catastrophic effect on the project. Legal risks are most often mitigated by guarantees which are elaborated upon below from one of the participants—most commonly the host government.

The main construction risk is that construction will be stopped or significantly delayed. Sometime construction is delayed because builders do not have access to materials, but it may also be intertwined with other risks, such a political risk that may halt construction.

In a power project, for example, the construction risk may be that the builders will have delay or problems having equipment shipped to the site.

A technical risk may be access to a power grid for the distribution of power to customers. Because storing power can be very challenging, immediate access in proportion to demand is essential for a successful power project. A thorough feasibility study should examine construction risks as well as how power will be interconnected to the main power grid, technology compatibility issues, and how revenue will be calculated.

In order to mitigate some of the risks, parties can draft legal agreements that specify the terms under which the SPV has access to the grid, and how the power generation site will connect to the grid. Such agreements are instrumental for the success of a project, since access to the power grid is an essential component of generating revenue to repay loans.

Risk is a term often used to imply downside risk, meaning the uncertainty of a return and the potential for financial loss. In addition to financial risks, there are five broad categories of investment risks known as five risks.

Harry Markowitz in with his article, "Portfolio Selection". In modern portfolio theory, the variance or standard deviation of a portfolio is used as the definition of risk. Unlike exchange rate risk, interest rate risk indiscriminately strikes both domestic and international projects as well as ventures with multi-currency cash flows.

During the construction phase, the project does not generate revenue. However, draw-downs begin to produce interest payable, the amount of which depends on the level of interest rate during the year in which the project is under construction. Out of the total value of direct and indirect investments, the interest on draw-downs cannot be precisely defined with certainty ex ante.

Only a percentage of total investments consist of definite costs; this percentage 2 Gatti, Stefano, Project finance in Theory and Practice, India: Elsevier Inc. This cost item represent significant percentage of total costs; in fact, the more intense the recourse to borrowed capital, the greater the weight of the interest component. The risk the SPV runs is that unexpected peaks in the benchmark rate to which the cost of financing is indexed can cause in the value of the investments such as to drain project funds entirely.

For this reason, a rather widely used strategy is comprehensive coverage of the variable-rate loan throughout the entire project construction phase. Table 3. Results of Model 1 Analysis 3. Company size has a significant effect on profitability The results of the regression analysis for the firm size variable note that the regression coefficient is The t test results for the firm size variable obtained a negative value of In other words, Ho3 in this study is accepted and Ha3 decision is that the variables of business risk, liquidity and is rejected.

In this study, company size has a negative effect company size simultaneously have an effect and are on profitability, which means that large company sizes are significant on profitability. The magnitude of the influence of not always easier to obtain external capital. Companies that business risk, liquidity and company size on profitability is have good prospects in the future will influence investors in Results of Model 2 Analysis concluded that business risk has a significant effect on the capital structure of Islamic banks listed in the In other words, Ho4 in this study is rejected and Ha4 is accepted.

In this study, business risk has a negative effect on capital structure, which means that the use of debt to companies that have high business risk can reduce the possibility of losses that will arise. This is supported by the Source: Processed Data Trade Off Theory where companies with high business risk should use relatively low debt to avoid bankruptcy. Based on the simultaneous test model 2, the F value is obtained of 0.

Liquidity has a significant effect on capital structure decision is that the variables of business risk, liquidity, The results of the regression analysis for the liquidity company size and profitability simultaneously have an effect variable note that the regression coefficient is 0.

The t and are significant on the capital structure. The magnitude of test results for the liquidity variable obtained a value of the influence of business risk, liquidity and company size on 0. Business Risk has a significant effect on profitability this study, business risk has a positive effect on capital The results of the regression analysis for the business risk structure, which means that the company will pay its variable note that the regression coefficient is 0.

The t obligations in the future so that additional debt will provide test results for the business risk variable obtained a value of a positive signal. Company size has a significant effect on capital business risk has a significant effect on profitability in structure Islamic banks listed in the period. Thus Ho1 in The results of the regression analysis for the firm size this study was rejected and Ha1 accepted.

In this study, variable note that the regression coefficient is negative at business risk has a positive effect on profitability, which 0. The t test results for the firm size variable obtained a means that the higher the business risk the company has, the value of 0. Liquidity has a significant effect on profitability structure of registered Islamic banks in the The results of the regression analysis for the liquidity period.

In other words, Ho6 in this study is rejected and variable note that the regression coefficient is 0. The t Ha6 is accepted. Company size has a positive effect, meaning test results for the liquidity variable obtained a value of that the larger the company size, the easier it will be for the 0. Profitability has a significant effect on Capital positive value for market players, which will increase Structure the company's effectiveness.

The results of the regression analysis for the profitability 3. Investors are expected to consider the size of the variable note that the regression coefficient is positive at - company because it is proven to have a positive and 8, The t test results for the profitability variable significant effect on capital structure. Global Economy and Finance Journal. In other words, Ho7 in this study is rejected and Ha7 is accepted. This means [2] Anggawulan, Ida Ayu Saraswathi,dkk. Vol 5 No.

Ukuran profitability has a significant effect on proven capital Perusahaan, RisikoBisnis, Profitabilitas, structure. JurnalManajen, Vol 3 No. Agustina dan Sri Widia Wijaya. Variable AnalisisFaktor-faktorYang Mempengaruhi Nilai The direct effect of business risk on capital structure shows Perusahaan Pada Perusahaan Farmasidi Bursa Efek, the standardized regression coefficient is negative at The amount of direct influence PL p4 is Ho8 [5] Hermuningsih,Sri.

PengaruhProfitabilitas, Size in this study is accepted and Ha8 is rejected. The lower the Terhadap Nilai Perusahaan DenganSturktur Modal company's business risk, the higher the optimal debt risk.

SebagaiVariabel Intervening.