Understanding risk management in business

Superscript
17 November 2021
5 minute read

Risk is a necessary part of any endeavour, and it is impossible to run a risk-free business. Without an element of risk, there can be no reward. Furthermore, the events of the global COVID-19 pandemic have shown us all that unexpected events can make the world of business a particularly volatile place.

This must not, however, be a reason not to follow our entrepreneurial instincts. The answer is to think rationally about the risks that you and your business will have to confront. There are positive steps you can take to effectively reduce the risks you face as you venture through the world of enterprise.

What is risk management in business?

In simple terms, risk management in business is a process of identifying, categorising and analysing the risks that your business could face, followed by creating mitigation strategies and performing a cost-benefit analysis. These different areas will all be included in your risk management plan.

So, we have broken down the process of creating a business risk management plan into three areas:

  • Identification of risks
  • Mitigation strategy
  • Cost-benefit analysis

Business risk management plans

Creating a business risk management plan helps to clarify what is and is not an acceptable risk for the company on ethical, legal, and financial grounds. Not only that, but it also enables you to put plans in place to minimise the impact if the worst does happen.

1. Identification of risks

To fully identify the risks that your business faces, you'll need to consider three main things; possibility, probability and impact.

  • Possibility: What could happen? What are the possible risks associated with any given operation? Cover as many bases as you can with this one – think of technical, legal, logistical, physical, emotional, criminal, natural, and any other kind of risk which may apply.

    Be sure to include those which are out of your control or not easily predicted, for example, the national lockdown implemented to counter the COVID-19 pandemic.

  • Probability: Having identified as many possible risks as you can, now consider the probability of each of these occurring. Some may be out of your control, but it is still really important that you assess the likelihood of them happening.

    Consider ranking the risks you have identified in order of the likelihood they might occur.

  • Impact: For each risk identified, assess the impact that it would have on your business. Would there be legal penalties? Could you recover from a significant loss of resources? What about brand damage? Get really catastrophic with your thinking – what is the absolute worst that could happen in each of your scenarios?

Now that you have a list of risks, and ranked them according to the probability and scale of the impact you believe they could have. Having done this (and perhaps scared yourself silly in the process!) it’s time to move on to the more positive side of the process: mitigation.

Risk Mitigation

2. Mitigation strategy

So, you should by now have some idea of what risks your business could be exposed to, which of these risks are most likely to happen and which risks will be the most damaging should they occur.

Now start matching the ‘probability’ and ‘impact’ lists up. This will give you an idea of the risks most in need of attention.

For example, a risk with both a high probability of occurring and a high impact is one that needs serious consideration. A risk with a potentially high impact but a low probability of occurring is less worrying, but still needs thought. A risk with a low impact and a low probability of occurring needs no more than a quick discussion. And so on.

Once you’ve got an idea of the risks most urgently in need of mitigating, you can start bringing in plans to do so. There are two types of mitigation to think about: contingency, and impact reduction.

  • Contingency: A contingency plan is a plan designed to reduce the probability of a risk occurring. For example, if you have identified cybercrime as a risk, a contingency plan to mitigate that risk might involve staff training, the installation of new software, more security protocols and so on.
  • Impact reduction: As the name suggests, impact reduction strategies are all about reducing the fall-out from a risk should it occur. So, if you have identified legal penalties as something that could occur as a result of your business activities, an impact mitigation strategy may involve finding a legal expert work on retainer – or taking out the relevant insurance.

Cost/Benefit Analysis

3. Cost-benefit analysis

So, you have identified and ranked the probability and severity of impact of various risks, as well as taking steps to reduce the likelihood they occur and reduce the impact if they do. The last part of the jigsaw puzzle that is risk management is the cost-benefit equation.

Looking at the costs of the ideas you've identified in the mitigation strategy, can help inform which actions you take, as it may be impossible for your business to pay for every conceivable risk reduction option.

If a potential risk is high but the cost of a contingency plan is prohibitively expensive, you may be better off concentrating on an impact reduction strategy rather than investing in the contingency plan.

For example, if you have identified one transport route as riskier than another, the obvious contingency plan would be to take the latter route. However, if the latter route would cause significant delays (resulting perhaps in loss of sales, revenue, or customer satisfaction), then the lesser risk for your business is actually to keep using the faster route.

Cost-benefit analyses can involve tricky calls at times. Sometimes, cost, benefit, and potential impact get into a three-way Mexican standoff which can be very hard to navigate. This is when you really need to think hard about what your business can stomach and what storms it can weather.

Is the potential profit really worth it if the job may pose a danger to your workers? Can you afford to install the necessary security software to carry out the processes you need for a risky operation? And what about the ethical angle – does this job tally with your company values?

All in all, business risk management is never a clear-cut thing, but it is still infinitely preferable to the ‘head in the sand’ approach preferred by many businesses. Forewarned is forearmed, so make sure you have a full picture of what could go wrong, however scary it might be to think about.

As experts in protecting businesses from risk, Superscript offers a range of flexible insurance products that can be an important tool in your company's arsenal in the war on risk.

This content has been created for general information purposes and should not be taken as formal advice. Read our full disclaimer.

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