How to manage risks effectively (a complete guide)
By Indeed Editorial Team
Published 3 January 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Risk management is an essential part of business and if you're planning a career in a management or leadership role, a developed understanding of how to manage risk can be imperative. Many of the decisions that a business make may involve risks. As the decisions become more complicated or the stakes get bigger, risk management can be key to ensuring that the decision is the correct one. In this article, we discuss what is risk management, learn about the importance of managing risks and explore some strategies and processes to manage risks effectively.
What is risk management, and why do businesses manage risk?
Managing risk is the process where an individual, company or financial manager identifies, assesses and controls different risks within the business. Once they identify the risks, the risk manager may then devise a plan to minimise these risks. A successful risk management strategy may ensure that a company can stay in business by ensuring that they understand the different risks that may affect their company and how they can reduce this risk. You can use risk management to determine a company's internal risks, but it can also determine risks related to society.
Depending on the business you're working for, they may have a significant impact on the environment, the employees, the consumers and residents in the area. For example, a construction company may consider how their newest development may affect the local area, including the environment and the locals. The construction company may then use a risk management strategy to understand how it can reduce these risks. Risk management is not solely about ensuring that there are no risks within the business. Risk managers manage risks to understand which ones are worth taking and can help them achieve their goals.
What is the importance of risk management?
Every business, no matter how big or small, can have a risk management strategy in place. Risk can be a part of businesses and as the world becomes more globalised and more reliant on technology, the likelihood of risks might become more prevalent. With the threat of pandemics and climate change, understanding how all of these factors may impact the business can help the company reduce its risk exposure and stay in business.
Without a successful risk management strategy, businesses may unwittingly take on too much risk, which can lead to losses and problems that can lead to bigger problems within the company. For example, if an investment firm does not successfully manage its risk, it may make poor investment decisions which could lead to losses and a poor credit rating. This could result in fewer investors, which could have a detrimental impact on the firm. Therefore, risk management is important if you're thinking about becoming an investor or starting a business.
Risk management strategies
Most businesses and investors may follow a similar structure to identify risk within their work. Depending on the company, some may choose to avoid risk completely, while others may choose to retain a certain level of risk. Here are some of the main strategies that a business may use to manage its risk:
Potentially, the most simple way for a company to manage their risk is to try to avoid it completely. Although some risks can be unavoidable, such as external risks, companies can choose not to take on deals or invest in choices that come with risks of any level. The benefits of a deal or investment may always be calculated against the potential negatives and avoided if the potential risks outweigh the benefits.
This is also known as risk mitigation, and it involves risk managers finding ways to reduce the impact of a risk. For most companies, risk can be an unavoidable point of business. By choosing to accept risks, companies may understand how these risks can affect their business and how they can work to reduce the impact of these risks if they occur.
Risk-retention generally occurs when businesses or investors determine that they can accept a certain level of risk. This is usually the case when the expected profits of a deal or investment are deemed to be much higher than the risk. For example, an investment firm may make a risky investment if the potential profit from the investment is worth more than the money it puts in.
If companies choose to take on risk, they can use insurance companies as a risk transfer. Businesses pay a premium to insurance companies who may pay them money for any damages or liabilities that occur within the company. Insurance can be expensive, but it can ensure that companies can remain operational even if a risk occurs.
Risk sharing is the process of spreading the risk between multiple different entities. For example, businesses can choose to share their risks between investors, stakeholders or third parties. This way, if a risk occurs, the different entities share the losses between them, which therefore reduces their impact.
The risk management process
The risk management process is a framework for the actions that identify risks and manage them efficiently. If you're planning a career in risk management, financial management or are considering starting your own business, it's important that you understand the best way to regulate risk. Here are some steps you can take to do so:
1. Identify the risk
The first step to understanding the risks that expose the businesses is to identify them. There are many types of risk, and it's important to identify them all. The safest way to do this is to consult an expert who has a deep understanding of risk, as they can tell you about each risk and how much these risks could affect the business. Although you can choose to identify these risks manually, many may choose to use risk management software to identify them. This can be helpful because it allows every stakeholder to see the risk, allowing for a quick transfer of information.
2. Analyse the risk
Once you identify the risks, it's important to then understand the threat, such as the likelihood of the risk occurring and what could happen if the risk occurs. To do this, every factor, such as legal issues, monetary factors and external factors, can influence the risk. Although it can be difficult to quantify risk, you can estimate it. For example, if you're working out how much a competitor is going to charge for their new product, you can estimate the cost of production, marketing and distribution.
3. Evaluate the risk
Once you analyse the risk, you can then evaluate how important this risk is. Risks can be prioritised, and the more severe risks may take precedence over the lesser risks. A business may have many small risks that may have the potential to occur each day, such as small dips in the market. The business may also face a number of high priority risks, such as reputation risks or financial risks. Once you determine the ranking order of the business's risks, you can prioritise which requires immediate action and which do not require action straight away or at all.
4. Respond to the risk
Every risk, no matter the size, requires treating. Risks that can seriously affect the business require eliminating as much as possible. For example, you can reduce financial risks by spreading the risk out between many stakeholders. Alternatively, you can choose not to make a business decision with significant financial risk. You cannot protect a business from every risk. For example, environmental and political factors are largely out of control. There are ways to mitigate the risk. For example, the company can insure itself against flood damage or put measures in place to protect the company from an economic downturn.
5. Monitor the risk
Although it's easy to eliminate some risks, others may be constantly present. Therefore, it's important to measure and keep track of all the risks you identify so that you can ensure they're stable. If any change occurs, you can see it immediately and can put a plan in place to manage this change.
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