What are Risks?

Risks are inherent in a business because businesses operate in unknown and uncertain environments. It is essential to identify risks in a business or else they may impact a business in an adverse manner. For any organization, it is also important to ensure the management of the risk so that its negative effects can be mitigated.

Risk Management

Risk management is the process whereby risks are identified and steps are taken to minimize and for the management of these risks. The aim of risk management is to mitigate or lessen the negative impacts of risks. Since risks are an integral part of any business, so is risk management. Formulating an effective risk management strategy is essentially required for a business to ensure that its resources including financial and operational resources are effectively used and maintained to cover up for the risks. One of the most common ways of managing risks is to have insurance coverage for all liabilities or costs associated with the risks.

Risk management in simple words means to manage risks. Risks in a business must be managed for the following reasons:

  • To ensure that the resources of a business-like time, people, finances, and assets stay protected.
  • To protect the image and reputation that a business has built over time.
  • To ensure that people and the environment in which a business operates are protected from damages.
  • To reduce any legal liabilities that a business may have to face because of the risks through the use of insurance.

If risks are not controlled, it is not possible for a business to operate with the available resources in the environment. Risk management as a process deals with different types of risks that a business may encounter during the course of its operations. These risks are as follows:

Economic Risks: Economic risks are the external risks that a business may encounter because of economic fluctuations. The economic environment that a business is operating in is a dynamic one and the trend of the economy keeps changing. This puts the business at risk of losing its financial capital and assets sometimes. Therefore, a business must keep a close watch to identify the market risk and try to mitigate these using insurance strategies.

Compliance Risks: Businesses need to comply with different laws and regulations related to the different aspects of the operations. If a business fails to comply with the stated laws, it may face strict actions that may lead to the closure of the business. So, a business must always know the rules and legal bindings that it needs to follow so that it does not get adversely impacted by compliance risks.

Physical Risks: Physical risks include risks associated with the location, materials, and the products that the business deals in. An organization must always be prepared to handle such operational risks. one way to handle these risks is to make use of insurance policies so that the liabilities can be paid by the third party and not the business. For example, the buildings where products are manufactures must have fire extinguishers in place, so that in case of a fire or explosion, the damage caused can be mitigated and reduced. If the business is not prepared for such risk events, it may lead to huge losses of different types of resources.

Reputational Risks: The aim of any business is to have maximum customers so that it can earn maximum profits. However, reputational risks may arise because the business is unable to offer good quality products or meet the demands of the customers. An organization must be prepared for handling such risks with risk management solutions that aim at ensuring that the customers stay happy and satisfied.

Competition Risk: Businesses operate in a competitive environment and so competition risks are always present. In other words, a business may face competition from another business, attempting to sell better products or similar products at lower prices. In such a case, the risk management approach is to take into account the fact that competition risk must not result in losses in the business.

Risk Management Process

The process of enterprise risk management includes the following stages that risk managers need to carry out:

  • Identify risk
  • Assessing risks
  • Controlling risks
  • Reviewing the control measures

The first step is to identify the type of risk that the organization is exposed. It can be any of the risks stated above. Once risk identification has taken place, it needs to be assessed to know what the impacts of the risks are. The next step is to control the risks so that the impact of the risks can be mitigated. It is also essential to review the risk control measures to know how effective the measures are. If the control measures are not effective, new strategies need to be framed.

When it comes to managing risks, the responses to risks can be one of the following:

  • Avoidance of risk wherein the risk is completely avoided by getting rid of the cause of the risk.
  • Mitigation takes place when the possibility of occurrence of risk is decreased. Insurance is one way of mitigating risks.
  •  Acceptance is the response wherein the business accepts the risk and develops contingencies to reduce the risks.

As has been stated, any type of risk can have a negative impact on the business. Therefore, risk management strategies need to be framed. These management strategies can be positive and negative strategies.

Negative Management strategies

  • Avoid: This strategy avoids the risk altogether. Any risk can be avoided by completely eliminating its cause. For example, during the Covid-19 pandemic, many organizations scrapped all their new projects because all of these were associated with risks of failing.
  • Transfer: Transferring a risk means moving the risk to a third party. For example, an organization can shift the financial liability risks associated with injuries to an insurance company.
  • Mitigation: Mitigation of risk means that the impact of risk is minimized or the probability of risk is reduced to a specific extent. For example, a company may use new technologies to ensure that most of the products manufactured are defect-free.
  • Accept: Accepting risk means that a business accepts the risk and suffers losses or damages arising out of it. This is because no strategy is available or suitable to manage the risk in any manner.

Positive Management strategies

  • Exploit: Exploitation refers to increasing the chances of a positive risk-taking place. In other words, the risk is exploited so that the business can reap benefits from it.
  • Share: Sharing a risk means that business partners with another business or party to mitigate the impacts of the risks.
  • Enhancing: Enhancing a risk involves increasing the probability of the occurrence of the risk. In this case, a business identifies and uses the risk triggers.

Principles of Risk Management

The following are the principles of risk management that various organizations follow:

  • Organizational context: Every organization is affected by several factors and the environment that it operates in. this implies that every organization faces various types of risks and so risk management must be integrated for an organization.
  • Stakeholder involvement: Risk management must involve all the stakeholders throughout the decision-making process that involves the risks.
  • Objectives of the organization: The risk management process must be in line with the objectives of the organization.
  • Reporting: It is important to report all the decisions related to risk and risk management. In other words, communication is essentially necessary for the risk management process.
  • Roles and responsibilities: The process of risk management must be a transparent one. This requires every stakeholder and anyone involved in the process to have defined roles and responsibilities so that scenario analysis can be performed to be accountable for the decisions taken to handle the risk. 
  • Support structure: Every member of the risk management team must support the decisions related to risk management. This requires every member to know about the risk management process and intervene to mitigate or avoid the risk at the right time. Furthermore, the risk management team must support each other to create an environment whereby the team is able to brainstorm and create strategies that can lessen the adverse impacts of the risk.
  • Review cycle: Throughout the process of risk management, the information related to the risk must be reviewed and made available.
  • Early warning indicators: It is important to recognize the early indicators of risk. This is essential so that the risk can be identified at an early stage and risk management can be used to prevent the problem from converting into a huge one.
  • Improvement in a continuous manner: It is important for every organization to continue improving the risk management plans and actions. This will help the organization to manage risks in a better manner.

Applications and Context

Risks are an integral part of all businesses and it is essential to manage all the risks for every type of business. This is where risk management plans come into play. Businesses of all types, whether, small- or large-scale enterprises need to put into practice contingencies and risk management plans so that the adverse impacts of risks can be reduced or avoided. One of the best ways in which risks are handled is the use of insurance coverage, wherein a third party pays for the liabilities involved with the risks.

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for Business management and Operations Management courses.It is also studied under  

  • BBA  
  • MBA 
  • Regulatory Compliance 
  • Cybersecurity 
  • Financial Management 
  • Investment Management 
  • Credit Management 
  • Banking 
  • Stock valuation 

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