Final answer:
Analyzing a company's balance sheet uncovers three major financial risks: credit risk from defaulting debtors, liquidity risk regarding the conversion of assets to cash, and interest rate risk from fluctuating rates affecting the company's financial position.
Step-by-step explanation:
When analyzing a company's balance sheet, three major financial risks can be identified:
- Credit risk: This arises when debtors default on their payments, leading to unexpected financial losses for the company. This risk is visible from the accounts receivable section of the balance sheet, where high sums may indicate potential credit risk if debtors do not pay on time.
- Liquidity risk: This involves the risk of a company being unable to meet its short-term obligations due to the inability to convert assets into cash without a significant loss in value. This can be deduced by looking at current assets and comparing them with current liabilities to assess whether the company can cover its short-term debts.
- Interest rate risk: This occurs when fluctuations in interest rates negatively impact the company's financial position. A company may be exposed to interest rate risk if it has a significant amount of debt at variable interest rates, or if the interest rates on its assets and liabilities are mismatched. This information can be inferred from the long-term debt and fixed income investments sections of the balance sheet.
Investors in the financial market consider these risks because they directly affect the return and the stability of their investments. The greater the risk, the higher the potential return or loss. Effective risk management is crucial for maintaining a healthy financial status and ensuring investors' confidence.