What risk increases if debt is sourced from financial institutions?

When debt is sourced from financial institutions, increased interest risk becomes a prominent concern. This risk refers to the potential for rising interest rates over time, which can affect the cost of servicing that debt. If a business obtains a loan at a fixed rate, it may initially benefit from lower payments, but if interest rates rise in the broader market, the company may struggle to manage the cost of new financing required for future growth or refinancing existing debt. This scenario can lead to higher overall interest expenses, impacting a company’s profitability and cash flow management.

In contrast, operational inefficiencies, liquidity risk, and higher insurance costs do not primarily stem from sourcing debt from financial institutions. Operational inefficiencies relate more to how a business manages its internal processes and resources, while liquidity risk concerns the ability of a company to meet its short-term obligations. As for higher insurance costs, they are typically influenced by factors such as the nature of the business and risk management practices rather than the debt sources. Therefore, increased interest risk is directly linked to the dynamics of borrowing from financial institutions and the fluctuations in market interest rates.