Risk, whether financial, operational, strategic, or hazard, is something most companies have to deal with. One of the most effective ways to reduce the impact of risk on a company’s reputation, shareholders’ value, and earnings and capital is by implementing a comprehensive Enterprise Risk Management (ERM) strategy.
An effective enterprise risk management program is tailored to a company’s processes, infrastructure, and staff. It provides a guideline for reward or risk while aiding in risk identification for operational activities. If you are considering implementing an ERM program in your organization to ensure financial security and provide your company with a competitive advantage, the following are seven critical components you must consider.
Organization Objectives and Strategy
An effective risk management program should function in a business strategy context, so the first step to implementing ERM is determining your organization’s goals and objectives. Before ERM integration, you should establish the following.
- What your company wants to achieve in the next 5-10 years.
- Your target customer’s demographics.
- The market you want your organization to tap into.
- The parts of the country you want your business to capture.
- How much do you want your organization to earn or grow?
- The investors return.
By defining the company’s objectives, the organization can assess the potential risks in implementing the ERM strategy and establish the level of risk the company is willing to assume in the execution.
Risk Appetite
Once the organization defines its goals and objectives, the executives should determine the risk appetite. The risk appetite refers to the amount of risk a company is willing to take in pursuit of the desired returns. It is the amount of risk the organization will cushion without losing too many funds.
The risk appetite is the link that puts together the organization’s capital, business plans, strategy setting, and risk. A risk appetite statement is a reflection of your company’s risk management tactics and has a significant impact on the operating style and culture. Consider the company’s current risk profile, internal risk capacity, capability, mission, and vision to determine the level of risk to assume.
Be sure to seek risk intelligence services to create a clear risk appetite statement that enables your organization to understand which endeavors to invest in and what to hold back from.
Governance and Culture
For an enterprise management program to be successful, the organization’s culture must embrace and value it. Each member from all organization’s sectors should be involved in the risk management strategy.
To create, promote and reinforce an effective risk management culture, board members and leaders should oversee the risk program, implement practical management principles, and invest in culture training. Solid risk culture is evident when the staff communicates openly during decision-making and conflict resolution.
Risk Data
Risk managers must familiarize themselves with the company’s risk profile to implement an effective risk management and response framework. To achieve this, the company should collect, aggregate, and distribute the correct data.
With that being said, collecting risk data can be time-consuming and challenging. Consider investing in quality and reliable information systems to manage and protect risk data to help the organization create effective mitigation strategies.
Internal Control
Solid internal control is critical for a management system to integrate an ERM program. It helps the organization minimize the risk to a manageable level, often referred to as residual risk.
The residual risk is the risk that remains when the internal controls have been implemented. Internal controls refer to the organization’s preparedness for various situations, procedures, and cultures. A practical ERM framework should understand and maintain a stable internal control environment to protect the risk managers from being overwhelmed by inherent risks.
Risk Measurement and Evaluation
The board of directors and executives should measure and quantify the different risk types to determine which risks are individually and collectively significant. This enables them to establish where to center their time, energy, and resources to mitigate risks. Be sure to communicate and report all threats, controls, and responses to meet the governance or oversight bodies and shareholders’ requirements.
With that being said, various tools and techniques, including Sharpe Ratio and Value at Risk models, can be used to measure, evaluate, and quantify risks. Consider your organization’s size and scope to determine the best methodology and tools.
Scenario Planning
Enterprise risk management allows risk managers to determine previous risk responses that were ineffective. With this information, the organization can develop strategies to mitigate the risks should they reoccur in the future to minimize their impact on operational viability.
Endnote
An effective ERM program is instrumental to the success of your organization. ERM integration provides deeper insights into your organization, enabling you to mitigate risks and increase profitability. Incorporate the above components to create an ERM strategy tailored to your organizational needs.
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