Risk management: definition, steps, and best practices

In 2010, BP failed to perform ongoing risk management to analyze the threat levels of their most pressing risks. This, coupled with recent cost-saving actions meant that BP didn’t properly analyze the risks in the lead-up to their devastating 2010 oil spill. It cost the organization over $56 billion, let alone the tragic biological damage. Risk management is integral to any business, but there’s no roadmap from A to B. Read this article to discover the importance of risk management, and how implementing the right system, like Trustpair’s automated account validation, can secure your firm.

Learn how to manage supplier risks by mastering your vendor onboarding in our latest white paper.

Risk management, a definition

Risk management is a plan, with a set of measures, to reduce the occurrence of unwanted events. In simpler terms, it means handling uncertainty when there is a threat that things could go wrong.

For example, if you own an industrial business – like a plant – that handles dangerous chemicals, risk management could be planning for the event of a chemical spill. Counter-measures could include: planning for an evacuation protocol, containment measures, medical interventions, health evaluations, etc.

But risks are not just imminent hazards. In fact, at their core, risks describe a broader range of scenarios that could be harmless, or on the other hand, generate unwanted consequences. Therefore, risks can be derived from the supply chain.

For example, writing your workplace login information on a post-it note is risky, since it could be picked up by the wrong pair of hands. A fraudster who finds the note could impersonate you by logging into the system and sending themselves money from the company accounts. Or, the post-it note could simply end up shredded in safety without any consequences at all. This two-way channel of scenarios perfectly describes the term: risk.

Types of risks

Risk management is very common in the workplace, especially for regulated or enterprise companies. That’s because the risks often have impactful consequences, either by affecting people or creating financial damage.

Therefore, risk managers need to think about the categories that risks could fit into, such as:

• Financial: will these scenarios directly lead to financial loss, or impact future revenue potential? For example, one financial risk is entering into a merger with an enterprise without doing full due diligence on the data.
• Operational: will an event impact the ability to carry on as normal and complete day-to-day tasks, or affect accessibility to products and services for customers? For example, if one of your main suppliers goes bankrupt, do you have a backup to keep up with production? (Learn more about supplier risk management here).
• Legal: risks in this category could place your organization or staff at risk of legal repercussions, such as regulatory enforcement and civil court cases.
• Cyber: taking risks in the digital world can lead to your security systems becoming compromised or accessed by unwanted parties, such as hackers. You could be a victim of cyber fraud, which could in turn affect your finances and operations.
• Market-based: also known as systematic risks, events in this category could affect your entire industry, including all your competitors. An example includes the 2008 crash’s impact on the housing market or 2020’s Covid pandemic.
• Reputational: for example, a tweet from the CEO could affect the entire brand of the company, and how it’s seen by customers and the public. This could knock on to struggling to gain customers in the future.
• Medical: could an event cause physical harm to your employees or customer health? Often, but not always, medical risks are derived from product defections.

Risk management is about having a specific plan in case any of the above occurs. This means you can react in a coordinated, controlled, and reasonable way, without taking even more risks in the process.

Why is risk management important?

Risk management is an integral part of any business’ operations. Without it, companies could experience unforeseen events that negatively impact the firm. And while some of these consequences are minor, others can be catastrophic.

Here’s an example:

Of course, no one can foresee the actual consequences when an event occurs. Therefore, risk management is important as it helps to identify the possibility of harmful events, and can inform leaders in their strategy to prevent risks.

Overall, this aids in protecting your company’s operational efficiency, finances, and reputation. And, it signifies what resources might be required to work in compliance with a low-risk environment. It’s about being ready for the worst-case scenario at all times, even if the unwanted event never actually occurs.

The 4 steps of risk management

There are four key steps to a successful risk management strategy that companies should follow:

1. Identification
2. Analysis
3. Mitigation measures
4. Monitoring

Identification

Identifying risks is the first step toward risk management. After all, how can businesses expect to protect themselves against risks, if they don’t know what and where they lie? It’s important to know what you might be dealing with before making a plan.

Risk identification begins by making a risk statement, which generally defines the risk. Next, it involves using research, including interviews and project case studies, to look at the standard consequences of such risk, and how it might occur.

We’ve recently seen some regulatory bodies enforce the industry-wide sharing of events to help inform industries against fraudsters. For example, the EU’s Digital Operational Resilience Act requires firms to report a cyber-related incident that renders their services offline, even if only for a few minutes.

This type of open dialogue framework can be useful for companies in the risk identification stage, as it can help highlight risks that were previously unconsidered, and enable businesses to clearly detail the consequences of such risks before they take action.

Analysis

Risk analysis requires organizations to estimate two factors:

• The likelihood of the risk occurring
• The severity of consequences should the risk occur

A risk assessment therefore involves spotting the vulnerabilities in your current processes and systems that could either make this risk event more likely, or more severe.

Learn more about third-party risk assessments in this article!

For example, imagine your current invoice payment process simply involves receiving the invoice from a supplier via email and sending it straight to the accounts payable department to be paid. Without measures like vendor identity checks, or setting payment limits, your company could theoretically end up paying millions of dollars to a false supplier who never delivers their products.

For example, the SWOT-based analysis is a very common methodology for those completing a risk assessment. Many automated systems, such as Trustpair, can also help with this process, and they might uncover less obvious vulnerabilities that could be exploited, too.

Mitigation measures

Mitigation measures refer to the actions taken to prevent the risk from turning into an event or prevent severe consequences. To complete this step, risk managers must break down every process into the smallest steps, and optimize these to reduce risk.

Often, this means experiencing less efficiency, or higher costs. But companies must weigh up whether they can afford to take the risks, or would rather pay to plug their vulnerabilities and reduce the chance of a risk event. It works similarly to an insurance policy.

One example of a mitigation measure is implementing a company social media policy. While this could be seen as restrictive and limiting, it may also prevent employees from unwittingly sharing company secrets online or impacting the company’s reputation with embarrassing posts.

In January 2024, a scandal occurred for a baby company, Kyte Baby, when the CEO failed to offer flexible working to a new mother whose adopted baby was born prematurely. What made matters worse, though, was that the CEO took to social media to publicly speak on her decision, and it was largely considered “tone deaf” by the audience.

This significantly impacted the company’s reputation, with many customers claiming that they would now turn to competitors for their baby products. Mitigation measures such as partnering with a PR firm, or simply introducing a social media policy to handle the issue in-house would likely have prevented the same scale of reputational damage.

Monitoring

As with many business processes, ongoing monitoring and iterations are always required to stay on top of emerging threats. Risk monitoring processes are best done through automated means, as otherwise, your business must invest in 24-hour manual monitoring, which is prone to a higher chance of error.

Ongoing risk management requires regular reporting, whether incidents occur or not. This happens to maintain the optimal risk levels that were pre-determined by the team during the risk assessment phase.

Over the long term, teams should:

• Take advantage of real-time data feeds
• Access user-friendly dashboard
• Require active participation from team members

This, in combination with automated risk monitoring systems, should enable organizations to manage their ongoing risks.

Risk management response strategies

There are five basic principles of risk management:

1. Avoidance: manage the chances of an event by sidestepping the risk factors
2. Retention: workplaces can absorb the impact of risk events due to the lower likelihood of their occurrence
3. Spreading: risk spreading refers to the redistribution of assets or hazards across multiple departments, sectors, or team members to reduce the impact of an event. The four eyes principle is a good example of risk spreading. Indeed, it requires multiple members of the finance team to be involved with processes. This reduces the chance for things to go wrong.
4. Loss prevention/reduction: Often, risks can’t be avoided altogether, but they can be reduced by other measures. For example, many vehicles will come with a sign displaying their alarm and immobilizer details to avert theft.
5. Risk transfer: Transfer refers to the change of responsibility of a risk event, and is often managed by taking out insurance policies for specific risk events.

Each of these principles represents a different approach to risk and can change based on the manager’s mindset, environmental conditions, or business goals.

For each of the risks within an assessment, the manager can choose one or more of these approaches as a response. As part of ongoing risk monitoring, team members must constantly measure the effectiveness of their management strategies. If these strategies aren’t effective, they should change their approach.

The best practices in risk management

Risk management best practices can be applied to reduce the risk of events occurring, and their consequences.

Culture

It all begins with the mindset: employees at all levels of seniority should have a proactive attitude towards risk. This culture requires buy-in from leadership, to effectively trickle down through the different departments. Acting as one team against all manner of risks, organizations are more likely to thwart potential threats.

Training

Regular training is also required to help team members stay ahead of various risks. During these sessions, employees should undergo scenario testing to simulate genuine conditions and explore response plans. Even better, surprise drills can help teams mitigate risks, and this approach helps individuals remain suspicious of red flags.

Tools

Using software platforms that specifically aim to identify, assess, mitigate, or monitor risks is the key to confident oversight. Trustpair is one of these platforms. Our automated account mitigation helps companies manage their third-party risks across the supply chain.

Our system audits supplier data and makes sure no suspicious transaction takes place. Your business’s financial and procurement team can have a clear overview of its fraud risks and secure its supply chain.

Opt for Trustpair as part of your defense against external and financial threats.

The 411 on risk management

While each company has its management risk process, it helps to work from an established risk management framework. Here, you can break it down into identification, analysis, mitigation, and monitoring. Give your staff access to regular training and the best tools, like Trustpair’s third-party risk prevention platform, to manage risks with confidence and secure your financial operations.