What Is Risk?
What then is risk?
A general definition is the probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through pre-emptive action.
ISO 73:2009 defines risk as the effect of uncertainty on objectives. According to Wikipedia, risk is in essence the probability that an event will occur. There are risks out there with 100% probability of occurrence that are certain to happen in the future. Risk is really the probability of an outcome not being as you anticipated at the outset.
From a purely business perspective, risk is a measure of the ability and propensity to lose money or capital. As a rule of thumb, the higher the expected return or reward, the higher the risk, and the lower the expected return or reward, the lower the risk. While higher risk investments offer potential for greater reward, this is not guaranteed, particularly over the short term. With lower risk investments, that range is smaller and more predictable, but as you go higher up the risk curve the variance of returns is greater.
With interest rates across the developed world being so low, investors have had to have a re-think about how much risk they are willing to take on. So in order to generate the same level of historic returns, investors have to accept a lot more risk. With money put into bank accounts in the US, Western Europe or Japan, basically earning nothing, anyone who relies on generating a monthly income to live on has been pushed further up the risk curve. The problem investors have, however, is that the real risk of an investment is only known after the fact and that as you take on more risk, you don’t necessarily generate higher returns.
Investing should be about certainty of outcome at reasonable levels of cost. One of the key skills is to identify what could go wrong and establish how much money could be lost, and then look to limit the amount of money that could be lost if something goes wrong.
The world is governed by uncertainty and volatility and this gives rise to never-ending changes in risk.
Given all the other pressing priorities and time constraints, business operators are not in a position to focus pro-actively on risk management and governance.
The reality is that few business operators will take the time and effort required to properly identify and quantify the wide range of risks facing their businesses in the modern age.
Sadly, simply being aware of the risks is in itself not enough. One must then commit to a systematic approach to risk management, good governance, informed business decision making and risk mitigation.
The reality is that many businesses only think about risk when an event has happened, often resulting in a major loss.
The result is that many good and viable businesses have failed because of their inability to identify and manage risks.
Why focus on managing risk?
A pro-active and preventative approach to the management of risk, good governance and core compliance will not only materially lower the risk profile of a business but will at the same time improve its standing and position as a desirable employer, credible counterparty for larger contracts or tenders, see it attract greater support from suppliers and be seen as a credible potential borrower by banks and other credit or loan providers.