What Is Risk Management and Why Is It Important?

It’s easier to ignore the possibility of risks when the business is doing well — but not having a plan for potential unforeseen threats could be the most significant risk of all.

The risk management process involves identifying, assessing, and controlling risk factors that threaten an organization’s earnings and assets.

Risks may arrive from multiple sources, including legal liabilities, management errors, financial uncertainties, technological problems, workplace accidents, and even natural disasters.

Risks can also be positive. These risks are opportunities to improve the business value and may harm a company if avoided.

This article takes an in-depth look at risk management and why it is crucial to consider for organizations.

Risk Management Structures

A good risk management structure reveals existing risks, calculates uncertainties, and predicts their impact on the business.

Risk management strategies should be tied to organizational goals because of the domino effect on the goals. Companies must define their risk appetite, i.e., the amount of risk they’re willing to take to achieve their goals.

Therefore, risk management is not all about eliminating risks. It’s about managing risks so that companies know what risks are worth taking to meet organizational goals and bring them enough payoff.

Without a proper risk management plan, your company loses money and wastes valuable resources. Consequently, poor risk management results in inefficient management practices, costing your company time, labor, and resources.

Unprecedented risks can further slowdown project deliverables, resulting in delays, and unsatisfied clients.

Why is Risk Management Important?

In the era of globalization, risks have become more complex than ever. The widespread use of digital technology has, to some extent, led to the constant growth of risks.

Because effective risk management seeks to control future outcomes, it enables organizations to respond to potential threats proactively rather than reactively. Thus, it allows them to decrease the possibility of a risk arising and its possible effect.

Proactive risk management improves the chances of success. It ensures that management has all the necessary information to make informed decisions. In addition, it helps prioritize risks and address them accordingly.

A proper risk management plan reduces uncertainty as well as losses and expenses. For instance, an increase in competition can raise a company’s marketing expenditures.

So, a portion of the budget could be set aside for such incidents to avoid interest from sudden loans.

Furthermore, risk management might allow a company to continue to provide value to all customers even in the face of a crisis. This creates a good brand reputation in the market and boosts employee morale.

The most recent, ongoing crisis faced by organizations worldwide is the Coronavirus pandemic. The emergency disrupted the global and national supply chains, curbed demand, and negatively affected employees’ health and safety.

The pandemic strongly emphasized the importance of risk management, and organizations are investing in resources, like digital technology, to become resilient, agile, and sustainable. It has driven companies to adapt quickly to the crisis and plan to safeguard their supply chains against similar future concerns. This further increases the importance of forming a consistent and thorough risk management plan.

Categories of Risk

There are four main categories of risk.

• Financial and reporting risk: It includes risks associated with the market, distributors, suppliers, taxes, credit, and more.
• Operational risk: It involves risks related to day-to-day operations such as supply chain, labor issues, IT security and data privacy, and natural disasters.
• Strategic risk: Poor business decisions, customer relations, technological breakthroughs, changes in economic conditions, insufficient cash flow, among others, are all examples of strategic risks.
• Compliance and governance risk: It comprises risks related to regulations, ethics, international trade, etc.

Risk Analysis Process

A risk analysis process is a qualitative approach to risk management. It consists of 5 steps:

1. Identify the risks

Not all risks are apparent. Some cyberattacks quickly come to mind, while others, like natural disasters, are hard to predict.

To identify risks, managers and employees need to brainstorm the different sources of risk together.

2. Assess the risks

This is where the organization finds out the cause of risks to develop an appropriate risk management plan.

It analyzes if the risk is possible and the degree of impact on the business in terms of the projected financial loss.

3. Prioritize risks

Risks should be prioritized based on their impact on business objectives.

Since it’s impossible to mitigate all risks, prioritization ensures that significant threats to the business are tackled aggressively.

4. Respond to the risks

Once priorities are set, the organization assesses the alternative solutions to risks and selects the best alternative. There are three types of responses to threats.

• Mitigation: Mitigation involves reducing the projected financial loss by decreasing the possibility of the risk occurring.
• Avoidance: It means eliminating a specific risk by removing its cause.
• Acceptance: Sometimes, an organization may be compelled to accept a threat. It then develops a contingency plan to reduce the impact of the risk if it occurs.

5. Monitor outcomes and make adjustments

The organization then needs to monitor how well its problem-solving decision is working.

If there are deviations from expected results, the organization makes necessary adjustments to the plan accordingly.

Risk Management in Project Management

IT security, data privacy, and human errors are potential severe risks associated with project management. Risk assessment is, in fact, a crucial part of a simple project management checklist.

Final Words

Risks are always waiting around the corner. Some frequently occur, while others rarely take place. As such, all organizations must plan proactively and prepare for every kind of risk.

This will help them avoid unnecessary costs, stay aligned with company goals, and keep employees happy.

This article was original posted on the Fluent Pro website.