Business owners, management, investors, and leaders all have to consider risk as a huge part of their work and success. If you’re going to business school, hoping to become a leader, manager, or run your own company, risk management is an essential element. But what is the definition of risk management? If you want to pursue any kind of business degree, it’s extremely important to understand the risks that are involved in any business operation and how to assess and manage them.
Companies can mismanage business risk which can lead them to scandals, financial repercussions, safety breaches, potential strategy issues, management distrust, and more. Mismanaging risk can come when companies rely too much on historical data, when they make their parameters for risk too narrow, when they disregard risks that are obvious or don’t look closely enough for hidden risks, when they don’t communicate well, and when they don’t react well in real-time to issues. Companies need to define managing techniques and risk assessment capabilities as part of their business plan in order to demonstrate their capabilities.
Business risks are often mismanaged when companies don’t understand the purpose or definition behind risk management, or when they simply don’t want to put in the work to manage their business risks well. It can also be connected to time, effort, and money involved with risk management that a company doesn’t want to expend.
As a business owner or leader, it’s extremely important to understand how to strategize how you minimize risk for your organization and ensure that you are being careful and conscious as you make business decisions.
The definition of risk management is the process of finding, assessing, and controlling threats to your company’s financial security. The basic idea behind that definition is that a company will consider all the areas that could result in a problem for them, consider the best ways to handle a problematic situation, and then put controls in place to help keep that risk as low as possible. It also involves handling a problematic situation when it arises. This guide will dive into the examples and define techniques used for risk management to help business owners and leaders bring success to their organization.
The risk management process can look different for every business and situation. Some companies have entire enterprise risk management teams that focus on strategic risk, risk assessment, risk profiles, risk treatment, and risk preparation for every new product and strategy. Smaller companies may have only one person who focuses on risk assessment or it may simply be a task along with other responsibilities for a company. Before a business begins it’s important that they define and analyze their risk—business owners and investors both need to understand the risk before they really try and make a go of their company.
Management of risk is vital in making sure a company and leadership understand what the potential problems could be, helping them create solutions for those problems and mitigate their risk. A company that has heavy risk or doesn't have the management aspect worked out may find investors are not excited about giving money. They may also find that they run into more problems then they have money or time to fix. Taking risk management seriously can help a company be prepared for the future.
Business owners and investors may measure risk in different ways. One way may be the amount of money that could be lost if a problem arises. Another is the frequency of risk and loss that’s possible. Other risk measurements could be historical, specific scenarios, and customer impact. All of these ways to measure risk can be important for an organization that’s hoping to analyze, mitigate, or minimize potential risks for themselves and investors.
It’s easier to understand the strategy for how you manage risk when you learn how management works in real life by real companies. For example, a company may choose to avoid buying a new building because they’re unsure they can sell enough product to make the cost worth it. An investor may decide not to spend money on a company because they believe there is too much competition in the industry or their objectives don't line up well. Car manufacturers try to lessen risk by having extensive quality and safety checks on vehicles before selling them. Another business risk strategy may be when a retailer may release a new product in stages to see how it does with consumers before releasing the full line. Many business leaders use insurance companies to remove risk altogether. Some organizations have to accept risk, like medical companies, and understand that some risk is simply part of their business.
In the business world, managing risk is absolutely essential. Whether you’re a large company with an entire risk management process and strategic risk management department, or a small business owner that looks into risk management yourself, it’s a very important factor for your success. Your overall objective should be to make your company as safe as possible, prepared for the likelihood of a financial, physical, or technological problem.
Risk identification and risk management helps keep your company’s finances and reputation secure. It also can keep your company, the employees, and your customers safe.
Risk management statistics show its importance in business, such as:
62% of organizations have experienced a critical risk event in the past three years
Of the companies that had a critical risk event, they saw the most significant consequences in the following areas: Employee productivity (62%), operational efficiency (59%), employee safety (29%), competitive differentiation (29%), brand and reputation (28%)
Corporations paid $59 billion in penalties for compliance infractions in 2015
On average every organization has 130 security breaches each year
A data security breach can cost your organization anywhere from $1.25 million to $8.19 million
If businesses can mitigate the potential risks in their way they are better able to meet their business objectives. From financial benchmarks to customer service, risks can get in the way of your objective success.
There are both internal and external risks that can impact your organization with their likelihood of meeting objectives. Internal risks can be your employees, technology, actual physical risks inside a building, and more. External risks include the economy, natural disasters, politics, and more. Your business goals are focused around making sales and earning money, keeping customers satisfied, making sure your employees are safe and happy, among other things. Companies can learn how to mitigate their risks so that they are able to meet their goals.
Risk management can be more complex than just deciding to do or not do something. For example, in some instances the cost of the risk itself might be lower than the cost of prevention. So business owners may choose not to take risk management measures. In other cases, the risk is a necessary risk that the business has to accept and take on in order to move forward. Whatever business you’re in, risk management is complex but vital in your business operations.
Every business and industry has regulations and rules that govern their operation. That means there are legal risks with not meeting business regulations, and it can have great financial repercussions if you don’t comply. There are many kinds of business regulations you have to follow including:
Internal requirements—corporations will have requirements to form a board of directors, have director meetings, updating bylaws, and providing stock options
Compliance with the Fair Labor Standards Act—this rule establishes minimum wage, overtime pay, and more
Other requirements—there may be other paperwork and tax requirements required based on your industry and size of corporation
Non-compliance can result in financial issues for your company, problems for customers and employees, as well as a bad mark for your company’s reputation.
There are many techniques your company can utilize to lower your company’s risk. It’s important to carefully consider the risks and risk management techniques that will be best for your company. Some of these techniques include:
- Avoiding Risk. Avoiding risk is usually the most effective measure of risk management. Just like the name implies, with this technique you just avoid the risk completely. If you are successful, there’s 0% chance you’ll have a loss from that risk factor. That’s why avoidance is usually the first risk management technique used. Risk avoidance can be seen in businesses doing background checks on employees to avoid potential problems. It can also be seen in an investor deciding not to put money in an industry that is seeing economic loss.
- Transferring risk. Transferring risk is when a company knows that they have risk that they can’t avoid, and they want to hire an insurance or other third-party company to help them mitigate their risk. There are many examples of transferring risk—a company purchases insurance for their building or products to help keep them safe in the event of a fire, theft, flood, etc. Another example of transferring risk is when a company creates contracts with employees or clients through a legal company that helps offset any risk that might come in the future.
- Preventing loss. Preventing loss is when a company understands that there is some risk that they can’t avoid, but they put preventative measures in place to help reduce the impact of risk. For example, a company may store their inventory in a warehouse, which means it’s susceptible to theft or fire. They prevent the risk and loss by putting up security cameras and hiring a security guard. Another company may require passwords on their computers to prevent data and security breaches of their company information.
- Retaining risk. This technique involves handling risk within your own company instead of relying on outside sources. Companies use this technique because they often believe that they can handle risks themselves instead of paying for an insurance company or other vendor. An example of retaining risk is an organization that has an internal IT department that runs their computer security, rather than utilizing a 3rd party company or software. It can also be seen in a company that opts not to buy an insurance policy for a certain danger because they believe they would be ahead to save money on their policy, and that the cost would be less if the danger actually happened than paying regularly for the policy.
- Spreading risk. Spreading risk happens primarily for insurance companies who opt to work with other insurance companies to spread out the risk of large clients. For example, an oil supertanker purchases insurance. The company would then spread out the insurance through other companies so in the event of a disaster the cost and risk is spread out through multiple companies.
Risk is an inevitable part of business, but it’s important to make a plan for your risk management process so your company stays safe. Business leaders and owners alike need to understand and have a plan for risk management in order to be successful.