Risk management entails the identification, analysis, and response to risk factors that are a part of the business process. These risks can originate from various sources such as legal liabilities, financial uncertainties, technological issues, or strategic management errors.
Companies worldwide are working towards developing enhanced risk management techniques to improve their business. According to a survey, organisations incorporating risk management strategies are five times more likely to deliver confidence to stakeholders with better business outcomes.
All organisations, regardless of size, must have robust risk management strategies. It helps proactively identify and control threats that could impact the business negatively. Let’s understand what is risk management, why it is necessary, and its processes in this guide.
What is risk?
Before we jump into what is risk management, let us get a brief idea of what is risk.
A risk is the possibility of the occurrence of any unfavourable event which has the potential to maximise loss and minimise profits of the organisation. Any factor which threatens the company’s ability to achieve its set goals is a potential threat.
Types of risks
Risks in a company can occur due to both internal and external factors. Every company is different, hence the risks each organisation faces also have their differences. However, broadly classifying, the following are the most common types of risks:
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Technical risks
With digitisation growing at an exponential rate, every business is looking for a way to go online. Creating an online presence will help boost the profits of the business, however, it does have several added threats.
Running an online website will require you to have an excellent IT team to create the process of navigating through your website a smooth experience for your customers. Poor coding, integration issues or not having a secure backup can make your business fall prey to online hackers. Data breach is a significant risk that online businesses are facing.
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Financial risk
This type of risk can impact the profit of the business thereby restricting the ability of growth. You must be aware of your loan interest rates and how it impacts your cash flow. If the loan interest is higher than the cash flow rate, your business has a high risk of facing financial issues.
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Strategic risk
Every organisation has a business model. When the operations deviate from this model, strategic risks occur. Some reasons for such kind of risk are technological changes, legal changes, competitive pressure, or shifts in customer demand.
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Compliance risk
Depending on where your business is operating, there are some established rules that every organisation has to follow. If any company fails to comply with any regulations from the government, they will face compliance risk. These risks include - workplace health and safety violations, corruption, harassment or discrimination in the workplace, etc.
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Competitive risk
Every organisation has competitors. However, when the actions of competitors are negatively impacting your company, you face a competitive risk. These risks can be combated by building a loyal customer base. You can communicate your business values, provide quality service, ask for feedback, and focus on the products you deliver.
What is risk management?
Risk management is a process in which business risks are understood and managed proactively, boosting success and minimising threats. A risk is the potential of a situation or event to impact specific objectives.
Risk management focuses on anticipating what might not go according to plan and listing certain actions to reduce the uncertainty to a minimum level. The process includes assessing, addressing, and mitigating any possible threats.
Mismanagement of risks can lead to financial repercussions, scandals, safety breaches, and potential strategy issues. Every organisation needs to thoroughly assess all the problem areas and develop solutions to handle the situation.
Why is risk management important?
Risk management has never been more important than it is now. Modern businesses' risks have become more complex and fueled by rapid globalisation. Here are a few reasons why risk management is necessary:
- For planning: Risk management strategies play a crucial role in planning for the future. With proper awareness of potential risks, departments can effectively control threats.
- Informed decision-making: Risk management allows you to stay aware of your surroundings. The available data allows you to make quicker decisions across business operations. With more information, informed decisions can be made.
- Safer work environment: Greater awareness and visibility of business risks allow employees to prepare. Appropriate training is conducted to ensure safety.
- Improved productivity: Employees appreciate a safe work environment. Employer’s dedication to providing and maintaining a safe working environment encourages employees to work dedicatedly. This translates to higher productivity.
- Portrays leadership: Having proper risk management strategies helps create a sense of safety. The management can demonstrate to their employees that the leaders are taking steps towards their physical and mental well-being. This helps in strengthening employee retention, loyalty, and motivation.
- Boosts communication: Practising risk management efficiently can help find communication gaps. The strategies that a business creates should prioritise visibility, and stimulating communication.
- Financial savings: Any incident is prone to incurring direct or indirect expenses. Mitigating potential threats can help prevent financial losses, loss of working hours, or any property damage.
Five principles of risk management
The primary goal of risk management is to protect the assets of the organisation - including people, profits, and property. The five main principles of risk management have been listed below:
- Risk identification: The first step is to identify any potential risks in an organisation.
- Risk analysis: It includes assessing the probability and impact of the identified risks.
- Risk control: It involves steps towards communicating, minimizing, mitigating, or eliminating the impact of potential risk.
- Risk financing: In this step, financial resources are allocated to cover the costs associated with potential risks.
- Risk claim management: In involves dealing with any claims that might arise as a result of a risk.
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Risk management process
Risks can potentially cause a small delay or significant impacts to your business. It is very crucial to understand your risks and learn how to successfully manage them. Companies can still anticipate and mitigate threats with an established risk management process.
The risk management process includes the following five steps:
Step 1: Recognising the risks
The initial step of risk management is to determine all the potential risks that an organisation might have to face. There are various kinds of risks like environmental risks, market risks, legal risks, etc.
Identify as many risk factors as possible. Anything that has the potential or harm your business should be on your radar, including single-point failure risks, technological risks, or environmental disasters. Risks can be classified into four major categories:
- Financial risks: such as economic recession.
- Operational risks: like employee turnover or supplier failure.
- Strategic risks: such as viral negative feedback or new competitors.
Categorising the risks can help streamline the risk management process. Some common ways of identifying possible risks are:
- Discussing the issues with industry experts.
- Using employee experience. Ask them about the different types of risks they have come across.
- Perform audits with the help of professionals.
- Conduct group brainstorming sessions.
Once all the possible risks have been listed, keep a record of them in a risk log. This helps monitor the risks throughout a project’s lifetime.
Step 2: Analysis of the risk
After identifying all the possible business risks, they need to be analysed. In this step, the scope of the risk is determined. The risks are categorised depending on two factors: the potential impact and the probability of occurrence.
- Qualitative risk analysis: In this step, the criticality of the risk is assessed based on the impact and probability of the risk. Employers often leverage the experience of their team members or consult experts to evaluate the possibility of the risk occurring.
To understand the impact a threat may cause, you must consider how many operations it is affecting. These threats can be classified as high-risk or low-risk events.
- Quantitative risk analysis: The objective of this step is to analyse the financial effect of risk. This enables the financial team to visualise any extra budget which should be kept aside for the particular project.
Business owners will have to determine costs that have not been accounted for in the budget for things such as:
- Time loss because of the risk occurring.
- Additional incident and claims management costs.
- Additional labour expenses if the event occurs.
- Employee compensation costs.
Both steps will help an organisation ultimately prioritise its resources and focus more money and time on critical events before addressing the non-critical ones.
Step 3: Prioritise the risks
Now the prioritisation begins. Rank the possible risks according to their severity. The severity of a risk can be determined by understanding the probability of each threat event occurring and the effect it might have.
For instance, a threat that could cause little inconvenience but will not disrupt the business operations is a low-ranking risk. On the other hand, a risk that could possibly bring the whole business to a standstill is given a higher rank.
This gives the management an overall view of the projects at hand and helps pinpoint where the focus should lie. In this way, you can identify workable solutions for every risk such that the business operations are not seriously impacted during the risk treatment phase.
Step 4: Treat the risk
Now, the following step is to treat the risks according to their ranks. In this step, businesses develop and implement their risk management strategies. Start with the risk having the highest priority. Your risk management team will try to find potential solutions to reduce or mitigate the risk and pick a solution.
Even though it is impossible to predict and stop all the risks, the steps stated will allow you to recognise the changes you can implement to lower the chances of most risks.
Strategies for risk response
Based on the type, severity, and urgency of the threat, these are some possible response strategies you could implement. They have been listed below:
- Avoidance: Some projects come with serious risks that might damage the business operations severely. In such a scenario, if the task is not important for your project, you can simply avoid it, thus eliminating the risk entirely.
- Acceptance: It is not possible to avoid all risks. Sometimes the advantages of a certain task outweigh the hazards attached to it. In such a scenario, businesses accept the risk as inevitable and take no action to prevent it.
- Control/mitigate: Some risks cannot be avoided or prevented. You could work on reducing the probability of the risk occurring or its impact when it does occur.
- Transferring: Some risks are out of your control such as accidents or natural disasters no matter how much precaution you take. In such scenarios business transfers responsibility to insurance companies.
- Prevention: In a scenario where the risk has become unavoidable, the organisation works towards focusing on keeping the losses contained. This approach also prevents from the threat further spreading.
These risk-mitigating strategies should be incorporated into your business processes as naturally as possible.
Step 5: Monitoring the results
Monitoring, tracking, and reviewing the risk-mitigating results regularly helps determine if the initiatives were adequate or if they require further changes. In case any changes are required, the team members will have to adapt to a new risk management strategy.
When dealing with the results, avoid getting into a ‘fighter mode’. This will only make the process more tedious. Instead, have a calm and clear perspective to identify what is not working for your employees and how you can make it better.
Often companies require the assistance of experts for monitoring and deciphering the results. Enrolling in banking certification courses can help you learn from experts and excel in risk management.
Types of risk management
Risk management plays a crucial role in any organisation's management strategy. Risks can be of various types, some of which we have discussed earlier in this guide. Here, let’s talk about some of the different types of risk management.
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Financial risk management
This type of risk management focuses on mitigating risks related to financial investments and transactions. It is a crucial part of the risk management strategies of the organisation, helping it to safeguard the finances and make informed decisions.
Various types of financial risks are:
- Credit risk: Risk of loss due to borrower’s failure to repay the loan.
- Liquidity risk: Risk of not having enough money to meet the business's financial obligations.
- Market risk: Risk of financial loss because of changes in market condition.
A very common way of avoiding large financial losses is distributing your resources into various investment portfolios. Financial risk management helps in enhancing workplace safety. By proactively managing these risks you can create a safer work environment for your employees and minimise potential legal and financial liabilities.
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Operational risk management
This type of risk management deals with risks associated with internal processes - including systems and human error. The goal is to identify and mitigate risks such as security risks, supply chain risks, and business community risks.
Many organisations put together safety protocols and contingency plans to avoid operational disruptions. These can be caused due to accidents, natural disasters, or equipment failure.
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Strategic risk management
This type of risk management deals with risks related to the business’s long-term objectives and goals. It assesses risks associated with competitive threats, unclear regulatory conditions, and changes in the business environment.
By effectively practising strategic risk management companies can enhance their ability to adapt to changing market dynamics, gain a competitive edge, and fulfil their long-term goals. It is essential for organisational governance and creating strategies for driving sustainable success.
Conclusion
Risks in a business, no matter how big the organisation is, are inevitable. This is why having an effective risk management process in place can help proactively identify possible threats and guard against them. It allows businesses to asses which risk is worth taking and which isn’t.
Managing risks is a growing concern for businesses worldwide. Organisations are always on the lookout for professionals who can assist them in safeguarding their operations. If you want to make a career in this field, check out the Senior Leadership Program by XLRI and Imarticus.
This certified course is taught by industry experts to help you understand what is risk management and also the intricacies of the financial market, asset management, etc.
FAQs
What is a reputational risk?
Anytime a company’s reputation is hampered, either due to a past event or negative competition, it causes reputational risk. This runs the risk of losing customers and brand loyalty.
What are some of the internal risks which can impact a business?
Internal risks that can impact the outcome of a business are often caused due to decisions made by the management. In such instances, having policies that safeguard the working environment of team members is very effective.
What is risk sharing?
Oftentimes, when there is the possibility of a huge risk occurring, the risk is shared amongst a group. For instance, many investors pool their capital and each only bears a small portion of the risk that the company might face.
What is risk management in trading?
Risk management in the stock market entails identifying, assessing, and preventing risks. These risks can often materialise when the market deviates from expectations.
