Why Risk Management Is Important (With Strategies)
Updated August 25, 2023
Risk management is integral in business planning and helps you make better personal decisions. The risk management process is constantly present in daily activities, particularly in complex and challenging situations. Understanding the process of risks management can help you better evaluate the parameters of a situation and improve your decision-making. In this article, we explore risk management, explain why it is important, highlight how to create a risk management plan, identify relevant organizational structures, and outline some risk management strategies.
Why risk management is important
Here are some reasons why risk management is important:
Ability to effectively deal with risks: The process of risk management equips you with the necessary tools to effectively identify and efficiently manage potential issues. Once you identify a risky situation, it's relatively easy to classify and apply the appropriate management structure.
Sound decision making: With effective risk management, you have a reasonable foundation for your decision-making process. For instance, after applying a risk mitigation strategy successfully, you can adapt it for future occurrences of such risks.
Progress and development: With proper risk analysis and management, you can properly identify the obstacles in your development path. It also allows you to prepare for such eventualities, which may help increase the chances of success.
Proactive actions: You prioritize situations and deal with high-priority risks with more aggressive strategies with progressive risk management.
Profit management: Risk management gives the management the necessary information to keep the business profitable. For example, risk management can involve offering clearance sales to increase customer patronization during low patronage periods.
What is risk management?
Risks are a part of business operations, identified as the probability of losing value in financial and business dealings or otherwise. Some risks causes may include natural disasters, accidents, uncertainty in the capital market, legal liabilities, or situations that threaten a project's success. In turn, risk management refers to the process where an individual or business identifies, prioritizes, evaluates, and develops plans to mitigate the effects of these risks.
How to create a risk management plan
Here are the steps to help guide you when creating a risk management plan:
1. Identify potential risks
The first step to effective planning is identifying the potential risks that may affect a project. To have a holistic idea of potential obstacles, try to get the opinions of other parties involved with the project. Some risk identification methods include holding risk assessment workshops, conducting interviews with stakeholders, or making knowledgeable assumptions.
2. Analyze potential risks
After identification, the next step is determining these risks' quantitative and qualitative effects on your projects. You can conduct your analysis on three factors, they're, the likelihood of the risk occurring, the consequences of the risks, and the impact on the project. After identifying the consequences, you can rate the risks on a scale from the least probable to the most probable and identify if the impact is low, medium, or high. This grading process helps you plan accordingly as high impact risk naturally demands more attention than low impact risks.
3. Develop responses to risks
After analyzing the risks, you can start creating preventive and responsive measures to eliminate or reduce the impact of the risks. It's important to create these plans according to the project management plan. Understanding and applying the project parameters like the timeline, resources, and budget may help you develop actionable and specific plans.
4. Assign roles and responsibilities
After developing your strategies, you can assign specific tasks to each team member. Ensure each individual understands their parts and has the necessary resources to implement the strategy. Assigning clearly defined roles helps prevent confusion and ensures your response remains coordinated and organized.
5. Determine your risk tolerance
Discuss the results of your assessment matrix with relevant parties to determine the company's tolerance level. For instance, the risks may be more than they can condone, requiring the team to readjust the plan to avoid the risks. In addition, determining your risk tolerance may help you edit your strategies to fit the project objectives in some situations.
6. Create a risk register
You can compile the relevant information in a risk register. The register helps you organize and share the plan with the relevant parties. Also, you can make the document editable to for changes even after the plan is in motion. In addition, sharing the risk register with team members ensures they know the risks and the appropriate responses.
7. Continue monitoring the risks
It's important to monitor and identify potential risks throughout the project's duration. For example, if you discover a new potential risk, you can analyze it, add it to the plan, and develop a response to it. Also, inform your team members to monitor potential risks, make adjustments where necessary, and inform others of any changes.
Risk management organization chart and structure
The departments within an organization that partake in the risk management process include:
Employees in the risk management group evaluate the company's risks and formulate responses and plans of action for such threats. These threats include strategic management issues, IT security breaches, financial uncertainty, or legal liability. They also prepare the company's annual risk reports for shareholders, stakeholders, and potential investors.
Employees in this group regulate company operations and ensure they comply with applicable laws and regulations, such as internal code of conduct, procedures, and policies. They also perform risk assessment functions to identify risk-prone areas and implement control measures. For instance, they monitor incoming and outgoing employee communications, record written correspondence, review the company's transactions and financial activities, and set procedures for non-compliance. Employees in the compliance group undergo regular training sessions to ensure they remain updated on the changing regulations and policies within and outside the company.
Corporate governance refers to the practices, rules, and processes that direct and control a company. The guidelines created by the corporate governance group apply to all aspects of the company, including public disclosure of records, performance management standards, and policies for board seat assignment. They also balance the interests and assign responsibilities to stakeholder groups in the company, including C-suite staff, government entities, suppliers, and community members.
The ethics group controls company situations and policies regarding employee misconduct and improprieties, particularly executive leadership. They're also responsible for training employees on conflict resolution and ethical decision-making. They investigate both internal and external complaints of employee misconduct or conflict of interest. The ethics group reviews corporate policies to ensure they comply with the ethical philosophies.
The internal audit group regularly examines the performance and efficiency of the risk management and compliance teams to ensure that every aspect of the company's business adheres to set internal and external policies and regulations. Then they report the issues to the management and unit managers alongside recommendations to improve the internal procedures and systems, governance and risk management processes, and other controls. The internal audit group is typically an independent body to ensure no bias in the evaluation process.
The responsibilities of the risk assessment group involve researching and identifying present and future risks that may negatively affect business operations. Their responsibilities include data security issues, identifying new competitors, liquidity risks, product recalls, and public relation risks. The risk assessment group complements the corporate governance group, whose responsibilities depend on the discoveries of the risk assessment group.
The risk reporting group defines data collecting procedures regarding potential risks, employee compliance, and general policies. They also prepare clear and concise reports for the company's management and government institutions. When creating these reports, they use risk management information systems to identify the organization's risk profile, the changes in the profile from the last report, and the performance of the current risk management framework. The risk reporting group's report typically relates to financial misstatements, environmental issues, and drug or food safety issues.
Strategies for risk management
The five categories of risk management strategies include:
The easiest way for companies and individuals to effectively mitigate risks is to avoid them. Although some risks may be unavoidable, some situations directly result from a business's decisions and actions. This process refers to the total elimination of activities that may expose the company to hazardous situations that negatively affect its assets.
Risk reduction is also referred to as risk mitigation. The process involves identifying various means to mitigate the effects of risks, especially unavoidable risks. An effective way to reduce the effects of risks is to identify the different types of risks and prepare solutions accordingly. Ultimately, it's important to determine whether or not inactions may be more appropriate than applying your resources.
Risk-retention is also referred to as risk acceptance. The process involves companies and individuals determining how many risks they can accept. For instance, a company may invest in a particular project despite the obvious risks because the potential profits are greater than the risks.
This process shares the risks between different entities connected to a particular project. For instance, all parties involved share a portion of the risks in business, from the shareholders to the investors, management, and third parties, like the vendors. All parties involved share the profits and the losses.
This process often involves insurance covers. In this strategy, individuals and companies pay an agreed premium so that the insurance company bears the damages and liabilities. The risk transfer strategy benefits companies and individuals in emergencies and protects them financially.
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