Importance of Risk Management
- Amruta Bhaskar
- Mar 11, 2021
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In every business, from the small corner store to the large manufacturer, there are common challenges with insurance, claims, and risk in general. Buildings can be damaged by fire, someone could slip and fall, vehicle accidents often occur, or losses can occur as a result of defective products.
Now, more than ever, it is vital to the success of an organization to understand risk management and to learn to control liability.
Risk management encompasses the identification, analysis, and response to risk factors that form part of the life of a business. Effective risk management means attempting to control, as much as possible, future outcomes by acting proactively rather than reactively. Therefore, effective risk management offers the potential to reduce both the possibility of a risk occurring and its potential impact.
Risk is inseparable from return. Every investment involves some degree of risk, which is considered close to zero in the case of a U.S. T-bill or very high for something such as emerging-market equities or real estate in highly inflationary markets. Risk is quantifiable both in absolute and relative terms. A solid understanding of risk in its different forms can help investors to better understand the opportunities, trade-offs, and costs involved with different investment approaches.
Risk management is the process of making and carrying out decisions that will minimize the adverse effects of risk on an organization. The adverse effects of risk can be objective or quantifiable like insurance premiums and claims costs, or subjective and difficult to quantify such as damage to reputation or decreased productivity. By focusing attention on risk and committing the necessary resources to control and mitigate risk, a business will protect itself from uncertainty, reduce costs, and increase the likelihood of business continuity and success.
A risk exists where there is an opportunity for a profit or a loss. In terms of losses, we commonly refer to the risks as exposures to loss, or simply exposures. Fire is an exposure. Defective products or defamation are liability exposures. The loss of business that results from a damaged building or tarnished reputation is also an exposure.
Risk management structures are tailored to do more than just point out existing risks. A good risk management structure should also calculate the uncertainties and predict their influence on a business. Consequently, the result is a choice between accepting risks or rejecting them. Acceptance or rejection of risks is dependent on the tolerance levels that a business has already defined for itself.
If a business sets up risk management as a disciplined and continuous process for the purpose of identifying and resolving risks, then the risk management structures can be used to support other risk mitigation systems. They include planning, organization, cost control, and budgeting. In such a case, the business will not usually experience many surprises, because the focus is on proactive risk management.
Response to risks usually takes one of the following forms:
Avoidance: A business strives to eliminate a particular risk by getting rid of its cause.
Mitigation: Decreasing the projected financial value associated with risk by lowering the possibility of the occurrence of the risk.
Acceptance: In some cases, a business may be forced to accept risk. This option is possible if a business entity develops contingencies to mitigate the impact of the risk, should it occur.
When creating contingencies, a business needs to engage in a problem-solving approach. The result is a well-detailed plan that can be executed as soon as the need arises. Such a plan will enable a business organization to handle barriers or blockage to its success because it can deal with risks as soon as they arise.
Risks management is an important process because it empowers a business with the necessary tools so that it can adequately identify and deal with potential risks. Once a risk’s been identified, it is then easy to mitigate it. Also, risk management provides a business with a basis upon which it can undertake sound decision-making.
For a business, assessment and management of risks is the best way to prepare for eventualities that may come in the way of progress and growth. When a business evaluates its plan for handling potential threats and then develops structures to address them, it improves its odds of becoming a successful entity.
Besides, progressive risk management ensures the risks of a high priority are dealt with as aggressively as possible. Moreover, the management will have the necessary information that they can use to make informed decisions and ensure that the business remains profitable.