This article discusses everything you need to know about risk identification, risk assessment & risk measurement. Risk refers to the potential for something to go wrong or to have an adverse outcome. It is an inherent part of any activity or decision, and it is often impossible to eliminate risk completely.
There are many reasons to incur and manage risk. For example, taking calculated risks can lead to new opportunities and potential rewards. On the other hand, failing to properly identify and manage risks can lead to negative consequences such as financial losses, reputational damage, and other negative outcomes.
Risk management
Risk management is the process of identifying, assessing, and prioritising risks. Thereafter, executing strategies to minimise, monitor, and control the impact of those risks. It involves identifying the potential risks associated with a particular activity or decision, evaluating the likelihood and potential impact of those risks, and then implementing measures to reduce or mitigate the risks.
The process of risk management typically includes the following steps:
- Identify the risks: This involves identifying all the potential risks associated with a particular activity or decision.
- Assess the risks: This involves evaluating the likelihood and potential impact of each identified risk.
- Prioritise the risks: This involves ranking the identified risks based on their likelihood and potential impact.
- Implement risk control measures: This involves selecting and implementing strategies to minimise, monitor, and control the impact of the identified risks.
- Monitor and review: This involves regularly reviewing and monitoring the effectiveness of the risk control measures, and updating them as necessary.
What is enterprise risk management (ERM)?
The principles of enterprise risk management (ERM) are a set of guidelines that outline the fundamental elements of a successful ERM program. These principles provide a foundation for organisations to effectively identify, assess, and manage risks across the enterprise. The principles of ERM are as follows:
- Integrative: ERM should be integrated into the overall decision-making and strategic planning processes of the organisation.
- Flexible: ERM should be flexible enough to adapt to changing circumstances and the evolving needs of the organisation.
- Transparent: ERM should be transparent, with clear communication and reporting on risk management activities and their results.
- Collaborative: ERM should involve collaboration among all levels and functions of the organisation.
- Forward-looking: ERM should be proactive, anticipating and planning for future risks.
- Decision-making: ERM should support informed decision-making by providing information and analysis on potential risks and their impacts.
- Continuous: ERM should be a continuous process, with ongoing identification, assessment, and management of risks.
What is a COSO ERM framework matrix?
COSO is an acronym for the Committee of Sponsoring Organizations of the Treadway Commission. COSO is an organisation that was formed in 1985 to provide guidance on internal control and corporate governance. The organization is made up of five accounting-based sponsoring organisations.
COSO is best known for its development of the COSO ERM framework, which is a widely-used framework for managing enterprise risks. It is a matrix that provides a structure for identifying and evaluating the risks facing an organisation, and for implementing strategies to manage those risks. The COSO ERM framework consists of eight components:
- Internal environment: The internal environment refers to the culture, values, and leadership of the organisation.
- Objective setting: This component involves establishing the goals and objectives of the organisation, and determining the risks associated with achieving those objectives.
- Event identification: This component involves identifying the potential risks that could affect the organisation, including internal and external risks.
- Risk assessment: This component involves evaluating the likelihood and potential impact of identified risks.
- Risk response: This component involves selecting and implementing strategies to manage the identified risks.
- Control activities: This component involves implementing control measures to mitigate the identified risks.
- Information and communication: This component involves collecting and sharing information about risks and risk management activities within the organisation.
- Monitoring: This component involves regularly reviewing and monitoring the effectiveness of risk management activities, and updating them as necessary.
Identifying risk
Risk identification is the process of identifying the potential risks that could affect an organisation. There are different types of risks that organisations may face, including strategic risks, operational risks, and business risks.
Strategic risks refer to risks that could impact the long-term goals and objectives of an organisation. These risks may include things like changes in the competitive landscape, regulatory changes, or technological disruption.
Operational risks refer to risks that could impact the day-to-day operations of an organisation. These risks may include things like supply chain disruptions, data breaches, or equipment failures.
Business risks refer to risks that could impact the financial performance or viability of an organisation. These risks may include things like market changes, financial instability, or changes in consumer demand.
Risk identification involves identifying the specific risks that could affect an organisation, as well as the risk factors that contribute to those risks. Risk factors are the underlying causes or drivers of risks. For example, a risk factor for a supply chain disruption could be a lack of diversity in suppliers, or a lack of contingency plans in place.
Risk correlation refers to the relationship between different risks. Some risks may be correlated, meaning that they are related or interconnected in some way. For example, a market downturn could lead to increased financial risks for an organisation. Understanding the correlation between different risks can be important for risk management, as it can help organisations identify and prioritise risks, and develop more effective risk management strategies.
Risk assessment
Risk assessment involves evaluating the likelihood and potential impact of risks. It is an important step in the risk management process, as it helps organisations prioritise risks and develop appropriate strategies to manage them.
There are several methods that organisations can perform a risk assessment, including the risk map and the risk heat map.
A risk map is a visual representation of the risks facing an organisation, typically shown on a grid or matrix. The risk map typically plots risks along two axes: likelihood and impact. The likelihood axis reflects the probability that a particular risk will occur, while the impact axis reflects the potential consequences of the risk. Risks that fall into the top right quadrant of the risk map are considered to be the highest priority, as they have both a high likelihood of occurring and a high potential impact.
A risk heat map is a visual representation of risk, similar to a risk map. However, instead of using a grid or matrix, the risk heat map uses colour coding to indicate the likelihood and impact of different risks. For example, risks that are considered to be high priority might be represented in red, while lower priority risks might be represented in yellow or green.
Both the risk map and the risk heat map are useful tools for visualising and communicating risk information to stakeholders, and for identifying, performing a risk assessment and prioritising risks for further performance analysis and management.
Read more about risk, specifically risk management, risk monitoring, and risk mitigation.