Risk management is the process of identifying, assessing, and prioritizing risks in order to minimize their potential impact on an organization. It is an essential element of effective business planning and decision making, as it helps organizations to identify and mitigate potential negative consequences that could arise from their operations or activities.
There are several key steps involved in the risk management process:
- Identifying risks: The first step in risk management is to identify potential risks that could affect the organization. This involves looking at a wide range of factors, including the organization’s operations, the industry in which it operates, and the external environment.
- Assessing risks: Once risks have been identified, they need to be assessed in terms of their likelihood and potential impact. This involves evaluating the likelihood of a risk occurring, as well as the potential consequences of the risk if it does occur.
- Prioritizing risks: After risks have been identified and assessed, they need to be prioritized based on their likelihood and potential impact. This helps the organization to focus its efforts on the most critical risks and allocate resources accordingly.
- Developing risk management strategies: After risks have been prioritized, the organization needs to develop strategies to mitigate or minimize them. This may involve implementing new processes or procedures, introducing new technology, or other measures.
- Implementing risk management strategies: The final step in the risk management process is to implement the strategies that have been developed to mitigate or minimize risks. This involves putting the necessary measures in place and ensuring that they are effectively implemented and followed.
Effective risk management is essential for the success and sustainability of any organization. It helps organizations to identify and mitigate potential risks that could affect their operations, and enables them to make informed decisions that support their long-term goals.
Risk Management Plan
A risk management plan is a plan that outlines the steps to take to identify, assess, and mitigate identified risks. It is a proactive approach to addressing potential issues and is typically developed as the output of risk identification and analysis activities. The goal of a risk management plan is to minimize the impact of risks on an organization and its stakeholders. This is often done through the implementation of controls and other measures that reduce the likelihood of risks occurring or their potential impact.
The basic elements of a risk management plan are a description of each risk, an estimate of their impact and probability and an overview of the steps that are taken to treat each risk.
Risk exposure is a numerical estimate of the probable cost of a risk. This is calculated as impact × probability. For example, if there is a 10% chance that a million dollar house will burn down your risk exposure is $1,000,000 × 0.1 = $100,000. A more sophisticated analysis will also include the risk of partial losses such as a fire that only damages your kitchen.
Residual risk is the risk that remains after risk treatment. This implies that you have accepted a certain amount of risk as part of risk management. In practice, most risks can’t be reduced to zero and this would seldom be desirable as you tend to get decreasing returns if you over manage risk.
A secondary risk is a risk that is created by risk treatments themselves. Risk management can go too far and cause more problems than it prevents. As such, measuring and communicating secondary risk has value in preventing overzealous risk management steps.
Risk assessment is the process of identifying and evaluating potential risks in a systematic and structured manner. It involves identifying the sources of potential risks, analyzing the likelihood and potential impact of these risks, and determining the appropriate course of action to mitigate or manage them. In risk assessment, probability refers to the likelihood that a particular risk will occur. Impact, on the other hand, refers to the potential consequences of a risk when it does occur. Probability and impact can be assessed using a variety of methods, including single estimates or probability distributions.
A project team brainstorms risks with the input of the entire team and required subject matter experts such as an information security professional. They estimate probability and impact for each risk in a probability/impact matrix.
An IT program composed of dozens of projects models the risk of projects being late or over budget using reference class forecasting, a method of comparing projects to historical projects with similar scope and risk profiles.
An equity analyst develops in depth knowledge about a company and its industry in order to evaluate risks and rewards associated with a stock. If they downgrade a stock they may provide a list of high level risks associated with the firm in a note to investors.
A risk analyst may use statistical analysis to evaluate the risks associated with a particular investment or class of investments. They may use a large number of variables to estimate the probability of losses as a probability distribution. For example, the probability of a 10% loss on a particular investment might be 3% and the probability of a 100% loss might be 0.3%.
A small business lists out risks associated with a strategy to open a new retail location. They evaluate probabilities on a scale of 1-4 labeled as “very likely”, “likely”, “possible”, “remotely possible”. They evaluate impact on a scale of 1-4 labeled as “disaster”, “high”, “medium”, “low.” The business then uses the evaluations to prioritize efforts to avoid, transfer, reduce or accept each risk.