Contrary to the term’s implication, risk management is not the elimination of adverse effects on an organization’s finances. Rather, it’s the reduction of the elements that increase risk. This is done through the construction and implementation of proper decision making.
Risk is determined through the following equation:
Risk = Probability X Severity
Probability measures the chance of a risk occurring. Severity is a measure of how great the consequences will be.
For instance, what would be the chance a company’s IPO fails? If it did fail, what would be the severity of the consequences for the company? Risk management is used to calculate these variables. As a result, it helps determine whether an investment is worth it, if it needs to be smaller or if it shouldn’t go ahead at all.
Risk management is not only for enormous corporations. It’s also used to chart possibilities in small and medium-sized businesses. Risk management can be applied to personal investments as well.
Why Is Risk Management Needed?
There are multiple reasons why you may need to implement risk management. Primarily, it’s for the protection of you and others. It shields you from harm, be it physical or financial.
It also lessens your vulnerability to public scrutiny. With proper risk management, you can protect yourself and your assets.
The Steps of Risk Management
There are six steps to implementing risk management in financial situations.
First, you identify the potential exposures to loss. This comes in a variety of forms. Physically, you can be exposed due to identity theft or money laundering from an internal source. Digitally, exposure can come in the form of cybercriminal activity that takes hold of your financial data and the personally identifiable information (PII) of your clients.
After you detail the potential exposures, you should measure their frequency and severity. If you’ve been hacked recently, you will need to review if the attack was a one-time occurrence or if such attacks happen regularly or are likely to happen regularly. When the cyberattack did happen, how badly did it damage your finances or PII?
Measuring risk goes beyond just the information risk. It is also related to productivity. You take risks with the items you sell and how you manufacture them. Thus, you need to measure how frequently a product release failed or the severity of injuries on the manufacturing site.
- Once the first two items are reviewed the next thing a risk management team does is determine alternatives to minimize danger. The third factor of risk management is the examination of alternatives.
For instance, to reduce the risk of money laundering, a company could enact annual training on the consequences of the criminal practice and how workers can alert management to potential problems. It might also represent a regular audit of manufacturing to determine where improvements must be made.
As a fourth step, you would choose the best alternatives to minimize risk.
You would then implement those changes.
They might not happen simultaneously. Instead, the risk management tools would be applied slowly. That way, the sixth step of monitoring could take place.
Those who are part of the risk reduction team would review the changes to see if the dangers were mitigated. If so, then they would move on to the next alternative. If not, they’d need to find another means of lowering risk.