Effects of Financial Risk Management on Firm’s Profitability: Panel Data Econometrics of Selected Micro-Financial Institutions in Kenya

Abstract

Proactive risk management is essential to the long-term sustainability of microfinance institutions (MFIs), but many microfinance stakeholders are unaware of the various components of a comprehensive risk management regimen. This study was set out to establish the effect of financial risk management on profitability of firms listed in the Nairobi Securities Exchange (NSE) of Kenya, from year 2006-2012.  In the context of globalization, we are witnessing an unprecedented diversification of risk situations and uncertainty in the business world, the whole existence of an organization being related to risk. The notion of risk is inextricably linked to the return. Return includes ensuring remuneration of production factors and invested capital but also resources management in terms of efficiency and effectiveness. A full financial and economic diagnosis cannot be done without regard to the return – risk ratio. Stock profitability analysis should not be dissociated from risk analysis to which the company is subdued. Risk analysis is useful in decision making concerning the use of economic financial potential or investment decisions, in developing business plans, and also to inform partners about the enterprise’s performance level. Risk takes many forms: Operational risk, financial risk and total risk, risk of bankruptcy (other risk categories) each influencing the business activity on a greater or lesser extent. Financial risk analysis, realized with the use of specific indicators such as: financial leverage, financial breakeven and leverage ratio (CLF) accompanying call to debt, presents a major interest to optimize the financial structure and viability of any company operating under a genuine market economy.

Keywords: Risk analysis, Financial Risk, Financial Leverage, Breakeven points