Risk
Financial risk management
Financial risk management identifies, measures, and mitigates the exposures that threaten a firm's cash and solvency.
Definition
Risk management starts by naming the exposures: can the firm cover its interest, how much debt does it carry relative to equity, can it pay its bills as they fall due, and how long can it survive on its cash. Each is measured with a ratio, then combined into an overall picture.
The Lab blends coverage, leverage, liquidity, and cash runway into a single 0-100 risk score, then shows which input moved it. The score is a diagnostic: it points to where to look, and it is never a substitute for the underlying ratios.
Intuition
Solvency is a chain of promises. Risk management tests each link before it is stressed, and finds the weakest link first.
When to use it
- Stress-testing a company before a downturn.
- Deciding leverage and liquidity policy.
When not to use it
- Treating a blended score as precise: it is a triage tool built on simplified inputs.
Formula
Interest coverage
EBIT ÷ Interest expense
How many times operating profit covers interest. Below about 3x is tight.
Formula
Net debt to EBITDA
(Total debt − Cash) ÷ EBITDA
Years of operating cash needed to clear net debt.
Formula
Blended risk score
Weighted coverage + leverage + liquidity + cash runway
0 is resilient; 100 is severely stressed.
Worked example
Reading coverage first
EBIT 300,000; interest expense 100,000; cash 120,000; debt 900,000.
- 1
Interest coverage
300,000 ÷ 100,000 = 3.0.
- 2
Interpretation
3x covers interest but leaves little room for a bad year.
- 3
Cross-check
Cash of 120,000 is only about 1.2 months of interest, so the buffer is thin.
Coverage is adequate but not comfortable, and the cash buffer is thin. The risk score would flag liquidity and runway as the weak links.
Measured by
These scoreboard metrics track or interpret this idea across the Lab.
Common mistakes
- Looking at leverage without coverage, or coverage without cash.
- Ignoring maturity: short-term debt must be repaid soon regardless of the ratio.
- Assuming a healthy score means no single exposure is dangerous.
How it connects
is measured by
The target is the metric or diagnostic for the source.
- Ratio analysis: Coverage, leverage, and liquidity are read through ratios.
is an advanced form of
The source extends the target once the basics are secure.
relates to
Useful to study together, in either order.
affects
Changing the source moves the target.