Risk Management: Why Is It Important?

Risk management is a process of knowing how to identify, assess, manage, and mitigate threats that may lead to financial loss or affect organisation growth. Every business out there is susceptible to risk that might slow the growth process and also lead to significant financial loss.

Every organization or individual must prepare risk management plans. In this article, we will learn why risk management is important in finance.

Table of Contents

Risk Management Definition and Examples?

By definition, Risk management is a process of identifying and mitigating risk causing factors in a business. Any business operating in products and services faces a variety of risks from many sources, including financial risks such as debt traps, technology failures, management errors, accidents, or natural disasters.

When your organisation is big and is operating at a larger scale, then you need to keep this risk management intact. A well planned risk management strategy helps businesses mitigate various risk factors and also lower the losses.

risk management

Well, we do have to take some extent of risks in businesses and therefore there are two major classifications of risks i,e,. Positive risks and negative risks. Positive risks are the risks that could increase the brand value of a business or if missed, can also be taken as a huge setback.

Risk is everywhere, whether it is a business or investment. For example, let us suppose person X invested an amount of INR 2,00,000 in a single company stock. This might pose a higher risk, as when the company performs poorly, the prices might go down significantly and person X might face huge losses. On the other hand, if person X diversifies his investment across different sectors such as healthcare, technology, government bonds, and mutual funds. This might reduce the high risk of losing all money as if a company performs poorly others might balance the overall return.

Risk Management: Key Takeaways

The main objective of risk management in finance is to mitigate risk factors and use them as an opportunity to increase the value of the organization.
Risk management applies to industries of all sizes, whether it is a small scale industry or large scale industry.
There are a variety of risks such as financial, safety, machine failures, reputational risks, and others.

Why is Risk Management important in Finance?

Every business works by implementing risk management techniques to keep themselves prepared for any uncertain risks that may follow up with time. Risk management protects a company from major financial losses that may occur due to any system failure, financial losses, machine error, or many other factors.

There is no one in all solution when it comes to risk management. Remember risk management does not mean that all the risks get eliminated and you are in a safe space. It simply focuses on mitigating various risk factors that may affect the growth or normal working of an organisation.

In the current scenarios, risk management is of great importance. Nowadays, modern organisations are prone to a variety of risks as they are more exposed to a variety of risk-causing factors. With the emergence of digital technologies, there has been a surge in potential threats online.

Process of Risk Management

Let us discuss a common risk management practice that any organisation can follow. ISO 3100 provides a risk management process that may be used by any entity to identify, assess, and manage risks:

Identify the various types of potential risks your organisation is prone to.
Arrange them in various categories based on their intensity, i,e high-risk factors or low risk factors. You might also consider the damage it may cause.
Analyze the possible impact of each risk causing factor.
Develop an efficient strategy to avoid or mitigate the effect of risk-causing factors.
Keep an eye on and monitor the risk control measures you put out there.

These are general steps in moving forward with risk management techniques. Practically, you need to be more cautious and must not underestimate the importance of risk management. The end goal is to sort out a method to increase risk tolerance as well as measures to avoid risk causing factors.

5 Principles of Risk Management

The major principles of risk management are identifying, assessing, and controlling risk causing factors. The main objective of risk management is to ensure safety from financial or growth loss. There are five major principles of Risk management given below.

- Risk Identification: This is the first step in the risk management process where you need to identify the potential risk causing factors of an organisation. When organisations are big, potential risk factors are not similar to every sector, hence separate identification becomes important.
- Risk Analysis: At this step, you need to assess the threat level of the potential risk factors and place them accordingly. The risk analysis is based on the potential threat they possess. It is important to prioritise the risk found based on the enterprise objectives.
- Risk Control: This is where you get started with steps to mitigate or reduce the impact of potential risks. It is important to treat or respond to the risk conditions that might arise.
- Risk Financing: The process of accumulating financial aid to tackle the effects or costs associated with the potential risks.
- Claims Settlement: This step deals with managing the claims that may arise while analysing a risk factor.

Also, Check How to measure Financial Risks in Business

Benefits of Implementing Risk Management Practices

Well who does not want to reduce losses due to a variety of risks in business or investment? Check some of the benefits of implementing risk management practices below.

- Effective Planning: Risk management helps businesses improve their strategy and take every factor into consideration. With effective planning and strategy, your enterprise might lower the risk hazards and threats to the growth of business.
- Reduce Loss factors: When you take various risk making factors into consideration then the losses are reduced to a greater extent which makes a safer and healthier work environment.
- Improved Productivity: When a company effectively manages potential risks it also safeguards and motivates its employees regarding the work conditions and future prospects of the enterprise.
- Improved communication: Risk management also takes into consideration these communication gaps which could lower the productivity of an enterprise. It promotes teamwork and helps fix gaps in communication to strengthen productivity.
- Financial Savings: Risk management takes into consideration financial savings to fight various unpredicted risks that may occur. These financial savings might help in fixing any damage to machines, and properties. It can also help in replacing used or damaged parts of machines.
- Reduced Uncertainty: With risk management planning and strategies in place, we prepare to manage any unexpected challenges that might occur. The best part is we are not completely clueless.

Also, Check the Financial Ratio in the Business

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Risk Management FAQs

Q1. What is Risk management in Finance?

Ans: Risk management is a process of identifying, assessing, managing, and mitigating risk causing factors that may cause unforeseen losses in the growth of an enterprise.

Q2. How does risk management work?

Ans: Risk management reduces the unexpected loss that may occur in the working of an enterprise. It works by taking into consideration various potential risk factors that might cause severe losses in the workings of a business. It generally works by identifying, analysing, controlling, and monitoring the risk management factors.

Q3. What makes a good risk management process?

Ans: Risk management does not completely eliminate the potential risk factors and losses incurred due to them. Risk management techniques are effective when we carry out a systematic, structured, and proper identification and analysis of the risk factors effectively.

Q4. What are the 5 principles of risk management?

Ans: The five principles of risk management techniques are given below

Risk identification
Risk analysis
Risk Control
Risk Financing
Claim settlement

Q5. What are the 5 stages of risk management?

Ans: The five major stages of risk management are given below.
Identify risk factors
Analyse risk factors
Classify risk
Control and treat your risk.
Monitor Risk causing factors