Significant Financial Risks of Conducting Business Internationally

Conducting business internationally may often pose financial risks.

Conducting business internationally may often pose significant financial risks that a company's top management may be unable to predict or understand. Conducting business internationally requires that a corporation's managers become familiar with local policies and regulations as well as cultural issues. A corporation which conducts business overseas may also face currency, political and credit risks.

What is Financial Risk?

A financial risk is a risk of loss that originates from a corporation's business transactions. Contrary to operational risk, which means risk of loss due to human error, or technology risk, which emanates from technology malfunction, a financial risk arises because a firm engages in commercial activities with another company. For example, Company A.B.C. operates in 26 countries worldwide. Company A.B.C. may expect significant financial risks inherent to all these 26 countries.

Currency Risk

Currency risk means the risk of loss that may arise if currency rates move unfavorably. A corporation that engages in business activities worldwide may face currency risks if all countries in which it operates do not have the same currency or have currencies that may not convertible easily. Let's say our sample company A.B.C. operates in 26 countries that have different currencies. Company A.B.C. then has to manage and record financial information in 26 currencies before converting it to U.S. dollars.

Credit Risk

Credit risk arises when a counter-party (also known as business partner) defaults, due to temporary financial problems or bankruptcy. Credit risk increases a corporation's "bad debt" expense ("bad debt" are amounts noncollectable from customers). For example, Company A.B.C. may engage in business transactions with Firm Y., a Paris-based business partner. If Firm Y. files for bankruptcy, Company A.B.C. may need to record amounts that Firm Y. owes as bad debt.

Political Risk

Political risk arises from legal instability and social unrest in a country or a region. A corporation operating in several countries may face a significant political risk in its business activities. As an illustration, Company A.B.C. has 25 percent of total business activities related to Country A., which is experiencing a military coup. Company A.B.C.'s top management may be worried that the new regime could seize all foreign assets.

Risk Hedging

A corporation conducting business internationally may hedge (protect) against international financial risks by using certain tools and methodologies. To hedge against political risk, a corporation may partner with other local and international companies to invest in economic sectors. To protect against currency risk, a company may sign a swap contract with another company that allows it to exchange fixed amounts in different currencies at a specified date. To hedge against credit risk, a business firm may need to improve its credit history verification procedures and ask for bank guarantees in business transactions.

References

• D&B: Small Business Solutions: How Do You Minimize the Financial Risk of Doing Business Overseas?
• The Federal Reserve Board: Remarks by Chairman Alan Greenspan: International Financial Risk Management
• Country Metrics: Managing Risk in International Business