Importance of Risk Management to Business


Importance of Risk management and Business

A study of the importance of risk management to business has become important because ignorance of possible losses due to circumstances beyond the control of a business could cause a setback in profit targets.

You can not correctly predict the future when it comes to business and this exposes you to the risk of financial loss that comes from any deviation.

We can make financial budgets based on current indices and have it truncated by a change in circumstance beyond our control and that is the true essence of managing risks.

What is Risk?

Risk is the uncertainty surrounding an event.

This relates to the anticipation of a negative event occurring outside of our control which may lead to a financial setback.

Risk is different from Chance in the sense that the latter describes a situation where there is a possibility for gain or a loss but the former is to look at a loss or nothing happening.

A person’s investment in shares is a good example of a chance event. The result could be a profit, a loss or no change. For risk, we could consider a motor vehicle that could either be stolen or not stolen.

Classification of Risks

It is important that we have a better understanding of risk hence the need to classify the types that occur. They are as follows:

  1. financial and non-financial risks; financial risks refer to items and valuables that can be valued in monetary terms and replaced in case of loss e.g a car, house or jewelry. a non-financial risk cannot be put in monetary terms e.g change of taste, change of trend, bad publicity e.g. financial risks can be easily managed compared to non-financial risks.
  2. pure and speculative risks; pure risks are situations where there is either a loss or no loss e.g motor accident, fire damage while speculative risks refer to situations with a likelihood for gain e.g gambling, lottery, etc. pure risks deserve more attention than speculative risks
  3. fundamental and particular risks; fundamental risks are not personal. They are beyond the control of a large group of people e.g flood, earthquake, cyclone, etc. They are mostly natural disasters. Particular risks are more personal in nature and have some level of control e.g personal accident, fire incidence, etc. Particular risks are more controllable compared to fundamental risks.

With all these types of risk exposure to individuals and businesses, it is key to know how to manage them so as not to be adversely affected by their operations. Let us now look at risk management….

What is Risk Management?

Risk management is the correct recognition, reasonable classification and grouping, economic control of, and the approach to selecting the best method for managing risk.

For a business to have the confidence to thrive, all situations of uncertainty must be looked at critically and managed so as to avoid financial setbacks.

One of the common methods of managing risks is insurance. It is the transfer of risk to another entity called the insurer(or an insurance company) for a financial consideration(called premium). Insurance is also a promise to compensate you(the insured) for a financial loss. This loss can be experienced from the actions of a peril¬†which is also encouraged and influenced by hazards. For a risk to be taken care of by insurance, it must have the following qualities….

Nature of Insurable Risks

  1. fortuitous; there should be uncertainty to be insured against.
  2. financial value; ability to measure the risk in monetary terms.
  3. insurable interest; the person or entity insuring must have a legal relationship with the item of risk
  4. homogeneous exposure; there must be a large number of similar risks for the insurance company to provide for in order to form a pool.
  5. pure risks; situations of loss or no loss are to be taken care of not chance events
  6. particular risks; these are risks whose effect and impact are personal
  7. public policy; It is against public policy to insure a risk that is harmful to the public e.g insuring an armed robber.

Insurance can be used as a method of risk management when the conditions above must have been satisfied.

Other methods of risk management are as follows:

  • avoidance
  • risk retention
  • mitigation
  • acceptance

what is the importance of risk management?

A company can, therefore, look at its situation and map out the best way to manage its risk. The basic knowledge of what has been discussed here will best serve you in knowing what type of risks are inherent in your business and the methods available to manage them.

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