What is Risk Management? (PDF): Definition, Importance, Process, and Types
Before learning about risk management, first, we should know what the risk is. From the small stores to the large manufacturers, there are common challenges with insurance, claims, and risk in every business. Fire can damage buildings, someone could slip and fall, vehicle accidents often take place, or losses can occur because of defective products.
Risk is integral from return. Every investment contains some risk, which is close to zero with a U.S. T-bill or very high for something such as emerging-market equities or real estate in highly inflationary markets. Risk is significant both in absolute and relative terms. A solid sense of risk in its different forms can help investors to better figure out the opportunities, trade-offs, and costs associated with different investment approaches.
Definition of Risk Management
Risk management is the process of identifying, evaluating, and prioritizing risks followed by integrated and economical application of resources to reduce, observe, and control the probability or impact of unfortunate events or to maximize the realization of opportunities.
Importance Of Risk Management
To highlight the importance of risk, here are some reasons all employees should care about risk management.
1. Everyone Should Manage Risk
As most business people know well, sometimes the risk is necessary in order to achieve success. Despite this, we sometimes see risk management as “the department of no” — those who turn down any project plan that seems to have any potential risk. The purpose of risk management is not to wipe out all risks. It is to decrease the negative consequence of risks. By working with risk managers, employees can make smart decisions to prevent risks and improve the chance of being rewarded.
2. Makes Jobs Safer
Health and safety are integral parts of a risk manager’s role. They actively seek problem areas in the organization and look to identify them. They use data analysis to identify damage and injury trends and implement strategies to stop them from occurring again. This benefits employees in physical work environments, such as construction, but can also benefit office employees. A safer workplace is better for everyone and is impacted by risk management dramatically.
3. Enables Project Success
Risk managers help employees from all departments succeed with their projects. Just they have to evaluate risks and implement strategies to maximize organizational success. It can also apply to individual projects. If something goes wrong, there will already be a strategy in place to handle it. This encourages employees to prepare for unexpected risks and maximize project output.
4. Reduces Unexpected Events
Most people don’t like surprises, specifically when it has an organizational impact A risk manager’s goal is to find out all possible risks and then work to prevent them or best manage them. It’s impossible to figure out every risk scenario and address them all, but a risk manager makes unpleasant surprises less likely and serious. The risk management department should first place an employee turns to when it seems like something serious could go wrong and the risk management plan is already there for it.
5. Saves Time and Effort
Employees at all levels submit data to the risk management department when incidents occur. These tasks are often completed in the most inefficient ways. By integrating these tasks, the risk department can ease the burden of tedious data submission from employees, allowing them to direct time and energy towards their correct roles. With a solid process in place, it is easy for employees to agree to high ROI risk management initiatives and facilitate risk managers’ roles and receive the benefits of a formal risk management system.
6. Benefits Culture
An effective risk management culture is better for all parties, including frontline employees, risk managers, executives, and decision-makers. It makes a mindset of prevention and safety that passes through the organization and influences the actions of employees. It predicts possibilities for performance and sends a positive image to the public.
7. Guides Decision-Making
Decision-making is a difficult process, especially when making important choices that will have a large impact on future progress. Risk management data and analytics can guide employees in making wise strategic decisions that will help to fulfil organizational objectives. They can also evaluate the strengths and the weaknesses of a decision and provide recommendations on what risks to maintain and which to avoid.
Risk Management Process
There are five necessary steps that are taken to manage risk; these steps are considered as the risk management process. It begins with identifying risks, evaluates risks, then the risk is prioritized, a solution is implemented, and finally, the risk is controlled.
1. Identify the Risk
The first step of risk management is to identify the risks that the business is discovered to in its operating environment. There are many types of risks, including legal risks, environmental risks, market risks, regulatory risks, and much more. It is important to identify as many of these risk factors as possible. In a manual management environment, these risks are written down manually.
If the organization has employed a risk management solution, all this information is included directly in the system. The advantage of this strategy is that these risks are now transparent to every stakeholder in the organization with access to the system. Rather than this crucial information being locked away in a report which has to be requested via email, anyone who wants to see which risks have been found can access the information in the risk management system.
2. Analyze The Risk
Once your team identifies potential problems, it’s time to go a little deeper. How likely are these risks to take place? And if they take place, what will the consequences be?
During this step, your team will examine the probability and fallout of each risk to choose where to focus first. Factors such as possible financial loss to the organization, time lost, and severity of impact all play a part in precisely analyzing each risk. By placing each risk under the microscope, you’ll also expose any common issues across a project and further improve the risk management process for future projects.
3. Prioritize the Risk
After analyzing the risks, prioritization begins. Rank each risk by factoring in both its possibility of happening and its potential impact on the project.
This step gives you a comprehensive view of the project at hand and pinpoints where the team’s focus should lie. It’ll help you identify useful solutions for each risk. This way, the project itself is not interrupted in ways during the treatment stage.
4. Treat the Risk
After prioritizing the risks, dispatch your treatment plan. While you can’t expect every risk, you should have set up the previous steps for the success of your risk management process. Starting with the highest priority risk first, task your team with either solving or at least reducing the risk so that it’s no longer a risk to the project.
Effectively treating and moderating the risk also means using your team’s resources properly without hindering the project in the meantime. As time goes on and you develop a larger database of past projects and their risk logs, you can expect potential risks for a more proactive rather than reactive approach for more efficient treatment.
5. Monitor the Risk
Transparent communication among your team and stakeholders is crucial for the ongoing monitoring of potential threats. And while it may seem you’re herding cats sometimes, with your risk management process and its corresponding project risk register in place, putting tabs on those moving targets becomes anything but risky business.
Risk Management PDF
Risk Management Approaches
After the company’s exact risks are found and the risk management process has been applied, there are several strategies companies can take regarding different types of risk:
1. Risk Avoidance
While the complete elimination of all risks is hardly possible, a risk prevention strategy is planned to deflect as many threats as possible in order to avoid the costly and disruptive effects of a damaging event.
2. Risk Reduction
Sometimes companies can reduce the amount of damage certain risks can have on company processes. This is done by adjusting particular aspects of an overall project plan or organizational process, or by scaling down its scope.
3. Risk Sharing
Sometimes, the effects of risk are shared or distributed among several of the project’s members or business departments. The risk could also be shared with a third party, such as a dealer or business associate.
4. Risk Retaining
Sometimes, companies decide a risk is worth it from a business point of view, and decide to keep the risk and deal with any possible side effects. Companies will often keep a certain level of risk if a project’s expected profit is greater than the costs of its probable risk.
Types Of Risk Management
Business enterprises take these types of risks themselves in order to increase shareholder values and profits. For example, companies offer high-cost risks in marketing to introduce a new product in order to gain higher sales.
Non- Business Risk
Non-business risks are not under the control of firms. We can term risks that originate out of political and economic imbalances as non-business risks.
Financial Risk as the term refers to the risk that includes a financial loss to the firms. Financial risk arises because of instability and losses in the financial market caused by movements in stock prices, currencies, interest rates, and more.
Limitations of Risk Management
- Using data in decision-making processes may have poor results if simple indicators are used to reflect the much more complex realities of the situation.
- Adopting a decision throughout the entire project that was intended for one minor aspect can lead to unexpected results.
- Lack of analysis, expertise, and time.
- Computer software programs have been built up to simulate events that might have a negative impact on the company.
- Analyzing past data to identify risks requires highly trained people. These individuals may not always be elected to the project.
- Value-at-risk efforts focus on the past instead of the future. Therefore, the longer things go effortlessly, the better the situation looks. Sadly, it creates a downturn more likely.
- Risk models can provide organizations with the false belief that they can assess and regulate every possible risk. This may cause an organization to ignore the possibility of novel or unpredictable risks.
- An organization’s risk management policies are insufficient and lack the history to make proper evaluations.
- Risk management is identifying, evaluating, and prioritizing risks followed by integrated and economical application of resources to reduce, observe, and deal with the probability or impact of unfortunate events or to maximize the realization of opportunities.
- It creates a safe work environment, increases the ability of business operations, decreasing legal liabilities, provides protection from threats, helps establish the organization.
- The risk management process involves 5 steps- Identifying risks, evaluating risks, prioritize the risks, treat the risks, monitor risks.
- Some risk management approaches are -risk avoidance, risk reduction, risk sharing, risk retaining.
- Some Limitations of the risk management process are- the false sense of stability, the illusion of control, failure to see the big picture, immatureness.
Terms Related to Risk Management
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