As the United States prepared to take a long holiday over the July 4th weekend, the Department of Justice set off some fireworks of its own: the department published a new edition of the FCPA Resource Guide, a one-volume compendium of all things related to the Foreign Corrupt Practices Act (FCPA). What does the Foreign… Read More
Business risks are situations or circumstances that can lead to a decline in profits, negatively impacting a company’s ability to achieve its goals and remain solvent. To effectively manage business risk, firms engage in a continual and systematic process of strategic risk assessment. The risk management process includes three critical steps: risk identification, risk exposure evaluation, and risk mitigation.
What is Risk Exposure in Business?
An organization’s risk exposure is a quantitative assessment of how vulnerable the business could be to various sources of business risk. Risk exposure is calculated as part of the strategic risk management process, summarized below:
- Risk Identification – Organizations begin the risk assessment process by observing risks in the business environment. Data and insights may be collected from across the business to support the identification of potential sources of risk.
- Risk Exposure Evaluation – The next step in the strategic risk assessment process is to quantify risk exposure. This can be done for each observed business risk as follows:
- Assign the risk a probability rating based on the likelihood that the risk would occur in the next calendar year. Probability ratings may be assigned as a percentage, or on a 10-point relative scale.
- Estimate the total impact to the business if the risk were to occur in the next calendar year. This should be estimated as a dollar value, and should account for remedial costs, lost revenue, wasted human resources, and reputational damage to the firm.
- Multiply the probability and impact of each observed risk to calculate the risk exposure.
- Create a ranked list of business risks where items with the greatest calculated exposure appear at the top.
- Risk Mitigation – Having quantified its level of exposure to each observed risk, the organization completes the risk assessment process by establishing risk mitigation strategies and creating an implementation action plan. Risk mitigation strategies should be proportional to the evaluated risk exposure for each individual risk.
Business Risk vs. Financial Risk – What’s the Difference?
Business risk and financial risk are related concepts – but they are not the same thing.
Financial risks are those that impact a firm’s ability to maximize its financial leverage and efficiently manage debt.
Business risks are those that impact a firm’s ability to profitably execute its business model, cover its operational costs, and achieve its strategic goals.
Four Sources of Risk Exposure in Business
Organizations should be aware of four potential sources of risk exposure in business.
Strategic risks emerge when an organization fails to execute its strategic plan for generating a profit.
Operational risks are related to failures in a firm’s daily operational processes.
Compliance risks are a significant source of risk exposure in 2021, especially for large organizations operating in highly regulated industries. As companies grow in size and expand the scope of their activities, compliance risks grow in number and become more difficult to manage.
Reputational risks are risks to a firm’s brand image or reputation in the marketplace. Damage to a firm’s reputation can result in a loss of market share to competitors and failure to maximize shareholder value.
How Do Organizations Manage Risk Exposure?
Businesses can manage their risk exposure by addressing individual sources of risk with detective and preventive measures that either reduce the probability of the risk occurring or reduce its potential negative impact to the business.
Companies are also adopting software-based compliance management tools that manage risk exposure by automating compliance workflows across the organization.