What Is Risk Management?
Risk management encompasses the identification, analysis, and response to risk factors that form part of the life of a business, and it is usually done with its best interest in mind. Effective risk management means total control of future outcomes proactively rather than reactively. Therefore, effective risk management offers the potential to reduce both the possibility of a risk occurring and its impact.
Risks Management Structures
Risk management structures are tailored to do more than just point out existing risks. A good risk management structure should also calculate the uncertainties and predict their influence on a business. Consequently, the result is choice between accepting the risks and rejecting them. Acceptance or rejection of risks is dependent on the tolerance levels that a business already defined for itself.
If a business sets up risk management as a disciplined and continuous process for the purpose of identifying and resolving risks, then the risk management structures can be used to support other risk mitigation systems. They include planning, organization, cost control, and budgeting. In such a case, the business will not experience any surprises because the special focus will be on proactive risk management.
Response to Risks
Response to risks usually takes the following forms:
- Avoidance: A business strives to eliminate a particular risk by getting rid of its cause.
- Mitigation: Decreasing the projected financial value associated with a risk by lowering the possibility of the occurrence of the risk.
- Acceptance: In some cases, a business may be forced to accept a risk. The option is possible if a business entity develops contingencies to mitigate the impact of the risk should it occur.
When creating contingencies, a business needs to engage a problem-solving approach. The result is a well-detailed plan that can be executed as soon as the need arises. Such a plan will allow a business organization to handle barriers or blockage to its success and that it can deal with risks as soon as they arise.
Importance of Risk Management
Risks management is an important process because it empowers a business with the necessary tools so that it can adequately identify potential risks. Once a risk’s been identified, it is then easy to mitigate it. In addition, risk management provides a business with a basis upon which it can undertake sound decision-making.
For a business, assessment and management of risks is the best way to prepare for eventualities that may come in the way of progress and growth. When a business evaluates its plan for handling potential threats and then it develops structures to address them, it improves its odds of becoming a successful entity.
In addition, progressive risk management ensures risks of a high priority are dealt with as aggressively as possible. Moreover, the management will have the necessary information that they can use to make informed decisions and ensure a business remains profitable.
Risk Analysis Process
Risks analysis is a qualitative problem-solving approach that uses various tools of assessment to work out and rank risks for the purpose of assessing and resolving them. Here is the risk analysis process:
1. Identify existing risks
Risk identification mainly involves brainstorming. A business gathers its employees together so that they can review all the sources of risk. The next step is to arrange all the identified risks in order of priority. Because it is not possible to mitigate all existing risks, prioritization ensures that those risks that can affect a business significantly are dealt with urgency.
2. Assess the risks
In many cases, problem resolution involves identifying the problem and then finding an appropriate solution. However, prior to figuring out how best to handle risks, a business should locate the cause of the risks by asking the questions “What caused such a risk and how would it influence the business?”
3. Develop an appropriate response
Once a business entity is set on assessing likely remedies to mitigate the identified risks and prevent their recurrence, it needs to ask the following questions: What measures can be taken to prevent the identified risks from recurring? In addition, what is the best thing to do if it does recur?
4. Develop preventive mechanisms for identified risks
Here, the ideas that were found to be useful in mitigating risks are developed into a number of tasks and then into contingency plans that can be deployed in future. If risks occur, the plans can be put to action and thus there would be no need to deploy emergency measures.
The world around us is essentially a giant sphere of risks waiting to happen. Since it is not a perfect world, our business ventures encounter many risks that can affect their survival and growth. As a result, it is important to understand the basic principle of risk management and how it can be used to help mitigate the effects of risks on business entities.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: