Managing Financial Risk With Finance

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You don’t need to be a rocket scientist to appreciate the role of finance in an organization. Finance is a team effort, and the best performing teams are those which rely on several sources of finance to ensure their success. Why finance?

Good companies need to be financially sound, not just run efficiently. They need to keep their costs down to retain a good return on their assets. So, what can they do to protect themselves from financial risk? There are two primary ways to reduce a company’s finance exposure:

Hold companies: Companies can buy the right of first refusal when they buy out another company’s interest. This means that if you were to buy a business in a “don’t buy”, it’s because you have negotiated a buy-out offer. Once you’ve got hold of that offer, you can take the goods back to your current owners and pay them off.

M&A: buying out another company’s purchase rights is one way to raise finance. You could offer to buy the business outright, or maybe offer it at a price less than the value of its purchase rights. In either case, you would need to obtain the sale agreement of the business for the purchase rights. You would then need to negotiate the terms of the sale.

Financial modelling: financial modelling is the process of laying out how a business will operate in the future. The most common financial modelling tool is “Business Overview” software, and this is also used by professionals as a means of forecasting business finances.

Transaction Costs: This term refers to the costs of transferring ownership of a business. You can calculate transaction costs by using a given value of the sale rights and multiplying by the number of years that it will take for the transaction to be finalized. Typically this is thought of as the cost of the transaction, but other items might include taxes, interest, the value of ownership and administrative costs.

Finally, there is finance related to the sale of a business. However, unlike in the case of M&A, this type of finance is not highly transactional. It is a much more subtle form of finance, which we will discuss in a future article.

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