Businesses operate in an ever-changing environment in which they are exposed to various risks. If the risks are not identified and resolved early, they can have a varying impact on businesses. While some may cause a minor difference to the working of their particular department, others may cause catastrophic loss to them. Irrespective of the gravity of the risks and the kind of impact they will have on a business, all risks need to be identified, assessed, categorized, resolved, tracked and reported. This calls for businesses to have a proper risk management process in place.
Before we tell you more about this process, we will like to inform you about various kinds of risks a business may encounter while operating.
Internal risks: These risks are related to internal processes and operations of a business organization and can be controlled. The risk of employee misconduct is a good example of internal risk.
Strategic risks: These risks are taken by an organization in the pursuit of value. The risk related to investing in building a new product line is an example of strategic risk.
External risks: These risks are largely beyond the control of the organization. A natural disaster like an earthquake is an example of an external risk.
Risks faced by businesses can also be categorized on these lines.
Legal risks: These risks may arise due to failure to adhere to established federal laws and laws of localities and states. They can lead to imposition of heavy penalties by the government and loss of business reputation. Employees charging wage and hour violations is an example of legal risk.
Environmental risks: Climate-change related risks can cause businesses to have increased insurance costs. Also, they may cause more damage to their property and resources besides leading to disruption of power and water.
Market risks: These risks involve losses on financial investment brought on by adverse price movements. Changes in equity prices or commodity prices or foreign exchange fluctuations are some examples of market risks.
Regulatory risks: These risks can arise due to new changes to laws and regulations which might cause losses to businesses. In some instances the changes can be so drastic that current business activities of a business may be deemed legal.
These are the risks that may impact your business in various ways. To negate or reduce their impact on your business, you need to have a certain mechanism in place that helps you identify, assess and resolve these risks in advance. This mechanism is the risk management process which consists of the following steps.
1. Risk identification
In this initial step, your in-house financial experts or specialists of an outside financial advisory firm will try to identify various risks that your business may get exposed to in its operating environment. These risks can be of different kinds that have been discussed above.
For identifying the risks, they will study the data related to your various processes, analyze the market scenario and talk with various stakeholders of your business.
2. Risk analysis
After the experts identify the risks, they will analyze them. The analysis helps them determine the scope of the risk. It also enables them to better understand the link between the risk and different factors within your organization.
They will analyze which business functions are being affected by a given risk. Accordingly, they will be able to determine the severity and seriousness of the risk. Different risks will have different impacts on your business. While some risks on materializing can bring the whole of your business to a standstill, others may cause minor inconveniences to your business.
3. Risk evaluation or risk assessment
Before planning solutions for management, resolution and mitigation of risks, they need to be categorized, ranked and prioritized.
The risks that may cause some inconvenience to your business are rated lowly by the experts. But the risks that can cause catastrophic loss to your business are rated the highest by them. Ranking the risks is important as it allows you to gain a holistic view of the risk exposure to your whole business organization. By knowing which particular low level risks your business is vulnerable to, your upper management need not intervene. But by knowing the highest-rated risks, your upper management can intervene immediately and allocate necessary resources for the intervention.
There are two types of risk assessments namely Qualitative Risk Assessment and Quantitative Risk Assessment.
4. Qualitative Risk Assessment
Risk assessments are intrinsically qualitative. While metrics can be derived from the risks, the majority of risks are not quantifiable. As an example, the risk of climate change cannot be quantified as a whole, only different aspects of it can be quantified. Your financial experts will find and use a way to to perform qualitative risk assessments while maintaining objectivity and standardization in the assessments throughout your entire business enterprise.
5. Quantitative Risk Assessment
Quantitative risk assessments are the best way to assess finance related risks. The use of such risk assessments is widespread in the financial sector because it primarily deals in numbers. This number can be in the amount of money, the interest rates, the metrics or any other data point. Numbers are critical for risk assessment in the financial sector. Quantitative risk assessments are generally considered more objective than qualitative risk assessments.