The concept of risk management originates from the business of insurance. It has assumed significance over the years as an important function of management. It basically consists of five processes that aim to mitigate business losses. No organization can completely eliminate risks but it is certainly possible to prepare for them.
Risk management basically means the identification and mitigation of losses. It is a systematic process by which an organization identifies, analyzes, prepares and reduces losses.
Apart from that, it also focuses on helping a business find profitable opportunities. Every business organization faces an unavoidable influence from its external and internal environments.
Management of risks reduces the chances of such factors affecting an organization negatively. Managers can either avoid or reduce risk or even transfer it to another entity.
Management of risks has, these days, become an inherent part of decision making and planning. Employees at all levels, from top management to lower levels, have to deal with risks.
This, in turn, implies that risks can affect all aspects of an organization’s management. Hence, knowledge of risk management is crucial for every organization.
Characteristics of Risk Management
Risk management is a systematic process that deals with the problem of uncertainty. It is an important discipline under the broad subject of management.
Secondly, one can also refer to it for responding to undesirable events. In this regard, it helps in preparing for worst-case scenarios.
Lastly, it is also a system that helps in making choices. It provides various alternatives and approaches to help managers select one that has minimum chances of losses.
Risk Management Process
Management of risks involves the following five key steps:
Step 1: Establishing the Context
Before dealing with risks, managers must be able to understand and identify them clearly. In order to do this, they first need to comprehend the context in which the risks arise.
In other words, managers need to figure which environment their business functions in and what risks may arise therein. They should also be aware of their organization’s functions, goals and core activities.
Step 2: Identifying the Loss
After understanding the context, managers should list down all possible risks that may arise. This will depend on the nature of the organization’s business, its environment, etc. For example, a company manufacturing chemicals may face the risk of leakage from its production units.
Risks can be of four types.
Firstly, physical risks are those which involve an organization’s physical (tangible) assets and environmental factors.
Secondly, Financial risks include the likes of insurance costs, payment of damages, loans, taxes, etc.
Thirdly, risks may also be ethical if they involve harm in the nature of one’s beliefs or reputation.
Finally, there can also be legal risks which arise from laws and regulations.
Step 3: Analysing and Evaluating Risks
Every organization faces several kinds of risks but the chances of them occurring differ in every case. Managers should analyze each possible risk individually and evaluate the chances of it happening. This is because they have to accord more importance to serious risks than less serious ones.
A business often incurs financial expenses for mitigating risks. For example, payment of insurance premium, costs of hiring security personnel, etc.
The greater the chances of a risk occurring, the greater will be its cost of mitigation. Analysis of risks, thus, helps in realizing how expensive it will be to prepare for a risk.
Managers can take the help of a ‘likelihood scale’ to fix the chances of risks occurring. This scale basically ranks risks on the likelihood of them causing losses. They can even rank risks in terms of priorities for this purpose.
Step 4: Treating the Risks
After identifying and analyzing risks, managers next have to treat them. This process can include avoiding risks altogether. Alternatively, it is also possible to reduce the possible impact of a risk.
For example, a factory can deploy safety measures and equipment to prevent injuries to its workers.
One can even transfer risks to other entities. This process includes the use of contracts and notices to shift any possible liability on others.
For example, shopping malls often shift the responsibilities of parked vehicles on their owners in case any damage occurs.
Step 5: Monitoring and Reviewing Risks
Monitoring and reviewing of risks is a continuous process. Managers need to keep checking the likelihood of risks occurring. They must also regularly follow up on their risk prevention strategies. This step is important because risks are inevitable and they never remain static.
Solved Examples on Risk Management
Mention the missing word in the following statements.
(1) Management of risks helps an organization in identifying all possible __________.
(2) The first step in the management of risks requires managers to understand the __________.
(3) __________ risks arise from laws and regulations.
(4) Managers can use the __________ scale to analyze risks.
Answers: (1) losses (2) context (3) legal (4) likelihood