What is risk management in finance?
Risk management is the identification, assessment, and prioritization of risks or uncertainties followed up by minimizing, monitoring and controlling the impact of risk realities or enhancing the opportunity potential by applying coordinated and economical resources.
Risk management is essential in any business. It lays foresight for returns on investments and projects all potential backlash a company could face by starting a new (or even routine) endeavor.
Before determining the most effective risk management strategy for your situation, there are five steps to take in first assess the risk and best solution.
Identify the risk
Risks include any events that cause problems or benefits. Risk identification begins with the sources of internal problems and benefits or those of competitors. Risks can be internal or external, so software can be used to identify the wide range of risk possibilities.
Analyze the risk
Once you have identified risks, you can thoroughly analyze the potential effects that each will have on consumer behavior, your company and other current endeavors.
Evaluate the risk
Now you can assign a ranking quality to the likelihood of each risk’s outcomes. This will help paint a picture around how severely a risk threatens a project or new product. You can also determine the magnitude that each risk potentially carries to destroy or support a new tactic. The magnitude is a combination of the risk likelihood and consequence.
Treat the risk
Since you have a grip on all possible risks and their severity, you can begin to treat the worst risks first. You’ll first want to look at the ways you can reduce the probability of a negative risk and then how to increase the probability of a positive opportunity. At this stage of risk assessment, preventative and contingency should be prepared so that there are no surprises as your move forward with action plans.
Monitor the risk
By now, you know your risks, their likelihood, what will happen if they occur and how to go about defusing any disaster that arises. What next? Monitor the risks by tracking involved variables and proposed possible threats to chain reactions. As your tracking system identifies changes, calmly treat the rising problem to avoid widespread ripple effects and the triggering of a big risk.
This brings us to the next important wave of risk management: treating the risk. There are several ways to treat risk, and they all depend on what type of risks are being treated and how serious those risk’s repercussions or opportunities are. Let’s take a look at the techniques.
Best strategies for treating the risk:
Best case scenario, you can avoid risk repercussion altogether. But in forfeiting all activity that carries risk, you also forfeit all associated potential return and opportunity. It is up to you what type of risk activity you want to play with.
Risk reduction implements small changes to reduce the weight of both risk and reward post-event. The reduction will require some process and plan manipulation, but it will save your company from a severe loss in the case of a high-risk manifestation.
Risk sharing or transferring redistributes the burden of loss or gain over multiple parties. This could include company members, an outsourced entity or an insurance policy.
Risk retention involves assuming the loss or gain, entirely. This option is best for small risks where the losses can be easily absorbed and made up.