Enterprise Risk Management Framework: 6 Core Components
The process of risk management in an enterprise cannot be a set of one-time actions. It will be effective only if it is a complex of purposeful steps. In addition, in order to consistently achieve business goals, the control of uncertainties must become a component of the overall management of the company. Learn from the material what are the main stages of resource management and why they are so important.
Why do organizations take risks?
Whether you’re crossing the road, ordering rolls from a new location, buying shares of Netflix, or taking an unusual route to work, risks and dangers are everywhere. Business has especially many dangers (it is also very sensitive to them).
Business is the conscious acceptance of danger for the reward of profit. Risk is a potential problem. The risk may or may not materialize, but it is impossible to run a business without thinking about risks.
Risk management in a company is an attempt to identify and rank all the risks that your business is exposed to. Risk management is a super-systemic tool that is an element of all popular methods of company management.
Business risks threaten a company to fail to achieve business goals. Management develops plans, works with the product, tries to maintain the profitability indicator, and if suddenly all efforts go down the drain, the risk has materialized. It is not always possible to avoid risks, but it is quite possible to reduce potential damage.
What is enterprise risk management?
Risk management is a system that includes a management strategy and tactics aimed at achieving the main business goals of an enterprise.
Modern economic science presents risk as a possible event, as a result of which positive, neutral or negative consequences may occur. If a risk involves both positive and negative outcomes, it is classified as a speculative risk. If the consequences are negative or absent at all, such a risk is called pure.
The purpose of risk management in the economic sphere is to increase the competitiveness of financial entities by protecting against the realization of pure risks.
By managing risks and studying their causes, the company:
- saves money and protects against losses;
- makes the working environment safe and secure;
- protects team members, clients and partners from potential harm;
- can identify your insurance needs to save money on unnecessary insurance premiums, etc.
When a company is prepared for various potential challenges, it is possible to grow and develop more confidently.
The right approach to risk management
Approaches to risk management in each enterprise are not the same. Different companies chose various methods of analysis, prevention, control of threats. But the main goal is the same for everyone – to set up the system in such a way as to minimize losses and missed opportunities for the company. Therefore, risk managers are required to have a creative approach, knowledge of modern methodologies and developed organizational skills.
To lay the foundation of a risk management system, you need to choose one of the generally accepted approaches as a basis:
- Active – establishing maximum control over existing threats, involves investment in maintaining the management system.
- Adaptive – the adaptation of economic activity to external conditions, which allows you to control only part of the uncertainties.
- Conservative – localization of losses, neutralization of their impact on the operation of the enterprise, while the cost of managing threats is minimal, the possible damage may be critical.
- Comprehensive or integrated – a combination of several approaches, provides high flexibility in risk management but requires investment to develop such a system.
In general, all approaches are good. However, the complex one is the most versatile and effective, although the costs of its implementation are high.
Components of ERM
In risk management, enterprises use the following components:
1. Organization’s code of conduct
The corporate ethics of the company is based on common values, traditions and norms of behavior of employees. Its base is:
- Company values shared by every employee.
- Following the general mission of the company.
- Faith in the success of the company.
- Productive cooperation between employees, allowing them to achieve common goals.
- Career development: training, courses, advanced training.
- Motivation, performance appraisal, remuneration.
- Standards of business conduct, dress code.
The totality of these characteristics constitutes the ethical basis. Each employee, coming to the company, follows these rules and thus forms the corporate ethics of the company.
2. Statement of the problem and goals
Depending on the strategic objectives of the organization, the characteristics of its activities, the attitude of management towards risk and the available resources, the following goals can be set for the risk management system, which will need to be achieved if the risk materializes:
- organization survival;
- business continuity;
- preservation of profit;
- stability of indicators;
- continued growth.
These goals are formulated before something happens.
3. Identification of risks and opportunities
The first step in the risk management process is risk identification. There are different concepts for this, and you should choose the one that best fits your organization’s practices and resources.
This includes type specification, basic identification and detailed identification.
4. Risk assessment and classification
There are different types of risks:
- organizational and others.
The classification depends on the type of company and the specifics of the actions.
5. Risk response and mitigation
Any risk management strategy is aimed at managing the likelihood of risk or its consequences.
The strategy for responding to pure risks provides several options for action.
- Risk avoidance involves changing the project management plan in such a way as to eliminate the threat caused by a pure risk, insulate the project objectives from the consequences of the risk (for example, reduce the scope of the project).
- The transfer and sharing of risks imply the shifting of the negative consequences of the threat and the responsibility for responding to it, partially or completely, to a third party, but the risk itself is not eliminated.
- Reducing (mitigating) risks involves decreasing the likelihood of risk realization, reducing the consequences of a pure risky event to acceptable limits – the risk will either not come true, or come true, but with lesser consequences.
Taking preventive action to reduce the likelihood of a risk or its consequences is often more effective than remedial action taken after a risk event has occurred.
6. Checks and balances
There are several methods. They are:
In order to effectively manage risk, a company must have many professionals, each of whom should be an expert in their field.
Professional risk management allows you to build long-term and short-term forecasts of the onset of risks, and, therefore, take preventive measures to reduce or completely neutralize the negative consequences of such a development of events.