What is Risk Management and Why is it Important?
Risk management is the process of identifying, assessing and controlling threats to an organization's capital and earnings. These threats, or risks, could stem from a wide variety of sources, including financial uncertainty, legal liabilities strategic management errors, accidents and natural disasters.
Every business is exposed to risks. Risks can be external and include competitor's actions and factors in the global economic market such as inflation or interest rates. Risks are also internal and may include insufficient skills available in the workforce or not enough cash to invest in stock (working capital) to complete customer orders.
Why would you want to manage these risks? The obvious reason is to put plans in action to reduce its effect. To deal with these risks, it is important the business can identify, measure and manage them. It is worth noting that this process should look at the current risks and possible future risks to be of real use to the business.
Firstly, the risks should be identified by using two management tools of SWOT and PESTEL analysis. These models look at the external and internal issues and risks that your business is exposed to. The SWOT looks at internal strengths and weaknesses as well as external opportunities and threats. An added benefit of a SWOT is to highlight what the business does well which can be used in future marketing to target new business.
Plans will need to be created to mitigate the risks. Our preferred model to follow is the TARA framework. Using the grading from the risk assessment above the risks will be placed on the TARA grid which will guide the business into four decision areas of transfer, avoid, reduce and accept. For instance, there may be a risk of theft to materials which can be transferred by using insurance. Accept will be used for risks with the least impact and likelihood of occurrence as its worth noting that the business will always face risks and it’s the business risk capacity which will determine how acceptable a risk is.
This framework should be updated annually or as frequently as the business believes is appropriate to track the risk level of each threat, ensure controls put in place using the TARA framework above have had the desired effect and to identify possible new threats. The risks faced and how they are being managed would be an appropriate point of discussion in an annual management board meeting. The business can take this framework further by introducing scenario planning for all the risks faced in order to get a better idea of the impact on the business.
Risk management examples:-
One example of risk management could be a business identifying the various risks associated with opening a new location. They can mitigate risks by choosing locations with a lot of foot traffic and low competition from similar businesses in the area.
Another example could be an investor buying stock in an exciting new company with high valuation even though they know the stock could significantly drop. In this situation, risk acceptance is displayed as the investor buys despite the threat, feeling the potential of the large reward outweighs the risk.
The important benefits of risk management include:-
- Creates a safe and secure work environment for all staff and customers.
- Increases the stability of business operations while also decreasing legal liability.
- Provides protection from events that are detrimental to both the company and the environment.
- Protects all involved people and assets from potential harm.
- Helps establish the organization's insurance needs in order to save on unnecessary premiums.
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