Financial Risk

Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority and you can order it here)      

The risk that the issuer may not be able to perform and comply with all requirements and expectations in issues of debt and equity securities.  In investments, financial risk, money risk (interest rate risk, the risk that current interest rates may rise and thus adversely affect current market prices of high grade fixed return securities selling primarily on a yield basis), and PURCHASING POWER RISK (INFLATION risk, the risk of erosion in purchasing power of the fixed return types of securities) are the classifications usually given for the principal risks associated with investing.

In managerial finance, financial risk is often considered synonymous with BUSINESS RISK, but a distinction may be made that purely financial risk relates to the risks of unfavorable or negative LEVERAGE and of higher costs of money or even threats to solvency associated with use of leverage beyond the optimum level of capital structure proportions.

Financial risk in managerial finance can be measured by the ratio of total debt (current liabilities as well as long-term debt) to total assets.  But more specifically, because of the usual viewpoint of common equity and the impact of leverage thereon, the denominator used is common equity (usually computed as tangible common equity, excluding the intangible assets).  An alternative way of measuring financial risk is to note the permanent capitalization, consisting of long-term debt and equity, and its proportions.

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