Risk Management Framework And Why It Matters In Business

An effective risk management framework is crucial for any organization. The framework endeavors to protect the organization’s capital base and revenue generation capability without hindering growth. A risk management framework (RMF) allows businesses to strike a balance between taking risks and reducing them.

Understanding a risk management framework

This is achieved by balancing risk-taking that ultimately leads to reward and risk-taking that fails.

The RMF is a structured process that:

  • Identifies potential threats.
  • Defines a strategy for eliminating or reducing the impact of these threats.
  • Provides mechanisms to monitor and evaluate the strategy once implemented.

The five components of a risk management strategy

To help clarify risk management requirements, the RMF framework follows six steps.

1 – Establish the context

Businesses must start by establishing context. What impacts have the potential to affect strategic objectives? Broadly speaking, these impacts may relate to the operational environment, regulatory policy, politics, and domestic or global market conditions.

2 – Identify the risks

Risks are determined by examining strategy or operations and then brainstorming potential events that would impact their successful completion.

Core risks should first be identified, or those that must be taken to drive growth and high performance.

Non-core risks, which should be eliminated or minimized, should then be prioritized according to:

  • Threats – or events that could harm an organization through destruction, disclosure, or intrusion.
  • Vulnerabilities – or weaknesses in systems, security, controls, or procedures that could be exploited by internal or external players.
  • Impact – how severe would the impact be on an organization if a threat or vulnerability were exploited?
  • Likelihood – or the probability of a risk occurring.
  • Predisposing conditions – are there factors inside an organization that increases or decreases the likelihood that a vulnerability will be exploited?

3 – Risk measurement and assessment

Using the prioritization factors in step 2, the business can identify risks that it will most likely be exposed to. 

Here, it’s important to measure exposure to a specific risk in terms of the overall risk profile of the organization. This is often hard to measure, but many businesses use aggregate risk measures such as profit and loss impact, value-at-risk (VaR), and earnings-at-risk (EaR).

4 – Risk mitigation

Risks deemed important enough to address must then be mitigated. Risk mitigation can be achieved through the sale of assets or liabilities or the purchasing of insurance. Ceasing certain activities or making crucial changes to human resource management practices are also effective risk mitigation strategies.

A decision must also be made on which risks to retain or absorb as part of normal operations.

5 – Risk reporting and monitoring

To ensure that risk remains at a manageable level, the risk management framework should continually be evaluated.

For high-impact risks, it is good practice to evaluate more frequently with a focus on the progress (or efficacy) of controls or treatment plans. Decision making on high-impact risks should only be undertaken by those with seniority within an organization.

6 – Risk governance

In the last step, systematically arrange the information into a standard risk governance system. Governance involves defining the roles of employees and segregating duties where required. 

Committees comprising upper management should also be created to mediate and manage risk long-term.

Risk management best practices

90% of startups fail! One of the primary causes of this failure is poor risk management. Risks are scary, and closing down a business is worse.

While it’s essential to focus on how your business will succeed, it’ll be foolish to ignore risks that can cripple it in no time. Some potential risks are fire, fraud, fire, or hurricanes, among others.

Securing your business against such risks will ensure future success. How can startups manage the curveballs thrown their way? Keep reading to find out.

As we saw, risk management is the process of identifying and analyzing risks that could be encountered as a project continues.

After identifying potential hazards, the manager helps the business meet its goals by following the set direction despite disturbances.

Risk management not only involves planning but also reacting to situations because there is a need to find solutions to risky situations.

Risk Assessment

This stage begins with assessing different risks your startup is exposed to and analyzing them.

How is your business exposed to both positive and negative risks? Once you determine the potential risks, check on what manner they can affect business operations.

It’s essential to estimate the damage that could be caused by the occurrence of adverse risks.

Some of the risks to consider in this stage are financial and operational risks. A country’s economy may lead to financial risks.

Strategic risks, on the other hand, include branding and competition. Identifying all these risks and planning how to counter them is an excellent strategy.

Risk Evaluation

At this stage, it’s crucial to measure the potential severity or frequency of identified risks.

During risk evaluation, you have to consider several factors such as regulations, laws, finances, technological malfunctions, socio-economic events, and potential competitors.

You can use heat map tools to determine how beneficial or dangerous a risk is. Remember to include severe and frequent risks.

You need to invest in many resources to solve or prevent severe risks. At the end of this stage, a manager will know what risks to prioritize and how to spend resources wisely.

Understand Your Financials

A financial analysis comprises the set of tools, frameworks, and methodologies to analyze the primary financial statements of companies to make internal (to make managerial decisions) and external (to determine the firm’s value or context) assessments. Financial analysis helps determine the state of a company’s valuation based on its main financial statements: balance sheet, income statement, and cash flow statement.

Knowing how you get money and how much you spend is vital. It’s equally important to store some cash for rainy days.

Manage to book-keep by yourself or hire a professional. Seeking the services of an expert is the better option.

Establish good relations with vendors and suppliers so that they can pay you in advance in case you encounter a financial crisis.

What will you do if you lose your best client? What if your most profitable product stops selling today? Ask yourself these questions and prepare how you can counteract predicted financial risks.

Take Protective Measures against Cybercrime

Nowadays, cybercrime is not something that any business should overlook. Any start-up can fall prey to it.

Hackers are now focusing on cloud-based systems which most organizations use.

To secure your startup against cybercrime, educate employees on how to use the internet safely, create safe passwords, and ways of protecting company data.

Seek Legal Aid

Most entrepreneurs find it expensive to hire legal aid during the first stage of their business

However, for a startup to succeed, legal advice is needed. Hiring a lawyer or an accountant to protect your assets and take care of financial liabilities will bear fruit with time.

Similarly, it’s crucial to hire an attorney to advise you on daily business affairs. Listen to close advisors who can point out mistakes and express their doubts.

Say No to Long Commitments

Some entrepreneurs are overwhelmed during the onset of a business, and this could be the path to their graveyard.

You’re not sure about your future even after taking calculated risks. Long term commitments could bring a severe financial burden.

Do not sign a long term lease for business premises. During the initial years of the startup, a lot of dynamics are involved.

Customers change and regulations might turn unfavorable. Your scope may also change with time. Flexibility is crucial for all startups in the first few years. You need to adjust in case anything happens.

Implementing Solutions

Once you identify potential solutions, allocate resources to each. Resources needed to implement a solution could be time, workforce, or money. Organize and plan everything at this stage to avoid confusion and delays.

Every employee involved in the process of risk management should be formally informed. This way, subjective differences won’t be encountered along the way.

If you keep procrastinating risk management, you’ll get caught unawares, and your business will fall in no time.

As you enjoy the growth of a startup, predict potential risks, and plan how you can prevent them. If you follow the above guidelines, your startup will prosper despite the occurrence of any risk.

Guest contribution on Risk Management best practices, by Ken Lynch.

Key takeaways

  • A risk management framework supports businesses in achieving their strategic objectives while minimizing detrimental risk.
  • A risk management framework identifies potential threats and then defines a strategy for minimizing or reducing them. Once strategies are implemented, the framework advocates continuously monitoring and evaluation.
  • To create an overarching risk governance system, a business must follow the six steps of the risk management framework. Importantly, the process clarifies threats that should be taken seriously and how they might be mitigated.

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