The Fundamentals of Risk Management

Word around the block is that people associate the word risk with something horrible or bad. You can’t really blame them as the general perception of risk is immediately translated to facing a loss or staring at a flashing red light.

The Fundamentals of Risk Management

If that introduction rings a bell of familiarity, you should read through this blog where we will be giving a breakdown of the types of risks that businesses face.

What is Risk?

To understand how to avoid, mitigate or manage risks it is important to understand what risks are and no, risks are not flashing red lights. Broadly speaking, risks are divided into two major categories. Let's explore what they are.

Systematic Risks:

When we face situations where the risk is undiversifiable and will be faced by the entire market it is known as a systematic risk or market risk, in this situation you can’t really mitigate the risk because the damage brought by the risk sends shockwaves to different industries and countries. One good example of such risk is climate change, this risk is shared amongst everyone equally and we can’t mitigate this risk immediately thus making it a systematic risk.

Unsystematic Risk:

You can tell from the name that this risk must be the opposite of systematic risk and you are right. Situations where a risk is industry specific and is either avoidable or diversifiable it is known as unsystematic risk. During the Covid-19 travel halt, hotels realized that that tourism industry was about to be affected so to mitigate that risk, hotels started providing staycations at a lower price to the locals making travel restrictions an unsystematic risk constraining to a particular industry.

What risks do businesses face?

Businesses face an assortment of different risks that can be easily avoidable and reduced via proper risk management, here are a few common risks that businesses face

  • Market Risk: As the name suggests, market risks refer to risks that associate with the fluctuations in the market be it commodities, equity, fixed asset, or exchange rates
  • Credit Risk: The worst thing that could happen to a business is customers defaulting so credit risk is counterparties failing to oblige to contractual agreements
  • Liquidity Risk: When a business doesn’t have enough cash/capital to roll over its debt they can face liquidity risks, also the worst type of risk to face. This risk usually occurs due to an incorrect use of leverage
  • Operational Risk: No business is safe from this risk, throughout the operation you will end up making mistakes, face technical issues or operational issues that will hinder progress.


The Fundamentals of Risk Management

Now that you know the basic types of risks that exist for business, it is only fair to tell you how to manage risks. To effectively manage your risks, first here is the 4-Step approach you can take.

Identify

First step is to identify the risks, as mentioned there are several types of risks that a business usually faces so it is important for you to identify what risk you are facing to manage it. Several methods i.e. Reviewing financial statements, SWOT analysis or PESTEL analysis can be used to determine whether the type of risk you are facing is an external or internal one.


Analyse

Second Step is to analyse the risk. After identifying the type of risk that you face it is important to figure out the severity of the risk that you are facing. There are tools and methods that can help you analyse the risk but the most common one is a risk matrix which helps measure the severity, probability, and the reoccurrence of a risk.



Treat

Third step is to treat the risk, perhaps the most important step of the risk management process. To plan for how you are going to deal with the risk you need to keep in mind the 5 approaches you can take to manage risk.

  1. Risk Avoidance: Don’t take part in activities that impose a risk e.g., don’t smoke to keep your chances of getting cancer low
  2. Risk Sharing: Sharing your risk with someone e.g., outsourcing operations to a third-party so that any risks you face will be shared by the outsourced company too
  3. Risk Retention: Accepting the risk as is to offset a greater risk e.g., choosing a health plan with lower premiums if you are relatively healthy
  4. Risk Transferring: Transferring the risk to a third party e.g., getting insurance for your car transfers the risk to the insurance company
  5. Loss Prevention and Reduction: Reducing or containing the impact of the risk when it is not possible to eliminate it e.g., Driving slowly can prevent an accident but if there is an accident it can help control the damages.

After going through the type of risk that you are facing and seeing what approach you want to take to deal with the risk so that you can think of the P.A.C.E.D method. What’s P.A.C.E.D you ask?

By forming a risk management strategy using one of the approaches and a P.A.C.E.D method, you should have a rigid and robust solution for the risk that you are facing.

Review

The final step of the risk management process is reviewing your results. Not only does this step provide very valuable feedback about your process, but it can also future proof your solutions! Anything you think can be changed? Add that in the review so that it becomes easier to tackle similar risks in the future.

Conclusion

This blog should have given you some insights about the fundamentals of risk management and some clarification about the types of risks that exist for businesses and some common methods to tackle the risks.

Remember liquidity risk?

Turns out that invoice settlement can take away a lot of liquidity from a company especially if it is a major invoice with lengthy payment terms, you can’t settle expenses or pay your employees.

Don’t worry, that is where Zetl can help! We provide services like Invoice Financing, Payroll Financing and Revenue Share. Through our online onboarding process our customers can unlock funds within 24 hours while enjoying full confidentiality!

If you would like to know more about our services or products contact us at hello@zetl.com