Enterprise Risk Management | 8 mins read

Complete Guide to Enterprise Risk Management For Business Owners

complete guide to enterprise risk management for business owners
Chloe Henderson

By Chloe Henderson

There are certain types of risks that every business is exposed to, whether it's changes in the economic state, shifting market trends, or even natural disasters. While some of these external threats are impossible to prepare for, this does not mean companies cannot maintain some level of control.

Organizations that practice enterprise risk management take a proactive approach to limit their exposure to threats by establishing a mitigation mindset in the workplace and standardizing their processes. This enables businesses to preserve their operational, financial, and managerial integrity while resolving risks.

Therefore, companies should consider introducing enterprise risk management into their internal operations to improve their overall stability.

What is Enterprise Risk Management?

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Enterprise risk management (ERM) is the planning process used to organize and control a business's activities to mitigate financial risks. In other words, ERM is a strategy used to preserve a company's earnings by minimizing threats against its operations.

The primary goal of ERM is to gauge and improve an organization's tolerance for risks. This requires businesses to create a plan of action that identifies and quantifies all potential dangers, so stakeholders can accurately prioritize threats.

Traditionally, ERM focused on internal risks that threatened productivity, operational efficiency, and compliance obligations. However, as technology has evolved and created new sales platforms, businesses now encounter many more obstacles.

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Modern practices now consider external risks, such as supply chain disruptions, government regulations, and investors, as well as technological threats, including software malfunction. By extending the scope, businesses need to adjust their risk management efforts to prioritize overall risk reduction.

Companies must consider both physical and non-physical risks, such as-

  • Security breaches
  • Equipment malfunctions
  • Natural disasters
  • Economic conditions
  • Malpractice
  • Bankruptcy
  • Market trends

ERM managers list and evaluate the potential impact of each risk to determine the company's appropriate response.

Why ERM is Better than Traditional Risk Management

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Many businesses have left behind their traditional risk management methods for ERM to improve their responsiveness and adaptability. There are several aspects that differentiate traditional and enterprise risk management.

Insurable vs Non-Insurable

In traditional risk management, companies would only concern themselves with threats that could be mitigated with insurance.

For example, company vehicles are insured in case of accidents and other liability issues, and many businesses keep workers' compensation insurance in the event that employees get injured on the job.
On the other hand, ERM considers non-insurable hazards, such as data breaches that can require significant funds to resolve.

Aside from supplementing what is required to address a non-insurable threat, these risks can also impact a business's reputation. Therefore, ERM takes proactive measures to preserve their profits and reputation.
Other non-insurable risks that ERM considers include-

  • Strategic goals
  • Social media
  • Vendor disruptions
  • Mergers and acquisitions
  • Lack of innovation

One-Dimensional vs Multi-Dimensional Assessment

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Traditional risk management only considers the severity of risks at the given moment. This often means that the threat has already occurred and has the chance to happen again.

For example, a business that puts out a wet floor sign only considers what will happen if an employee or customer falls and hurts themselves and places insurance where it's needed. However, they often do not think of the probability or aftermath of the risk.

ERM considers the likelihood that a threat may occur, as well as its potential effect on the company. By breaking down the different scenarios in which risk may appear, managers can outline the operation or process it threatens.

ERM also evaluates a threat based on-

  • Velocity
  • Pervasiveness
  • Persistence
  • The company's preparedness
  • Mitigation effectiveness

Many organizations make the mistake of immediately assessing risk without considering all of these aspects, which can significantly impact the effectiveness of the mitigation plan. By using a multi-dimensional assessment, businesses can ensure that they correctly prioritize risks.

Managing vs Analyzing Risks

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Traditionally, risks were assessed and handled on an as-needed basis within the department it affects. This often meant that other departments remained unaware of the threat, creating a much bigger risk from the lack of communication.

On the other hand, ERM practices consider possible interdependencies that can trigger additional threats, enabling managers to distribute resources and score risks accurately. Each hazard is analyzed by risk appetite and tolerance, so businesses can determine if they are under or over managing each threat, enabling managers to redirect resources as needed.

Siloed vs Holistic Approaches

By keeping threat evaluation within the department in which it occurs, businesses can create silos. These silos can significantly hinder interdepartmental communication, risk management, and holistic strategies, as some sectors remain unaware of the risks.

Risks can sometimes fall in between silos and remain undetected for long periods of time, wasting company resources. These threats are able to go unnoticed for so long because they typically impact a specific process but have minimal effect on the business as a whole. Stakeholders are often reluctant to take ownership of threats that fall between silos, especially those that occur throughout the supply chain.

ERM breaks down these silos to create a holistic view of threats, enhancing flexibility and responsiveness. While this may be relatively straightforward for small businesses, larger corporations often designate an ERM director to orchestrate this multi-functional approach.

Reactive vs Proactive Approaches

The reactive approach is often referred to as the rear-view method, as businesses evaluate a risk after it has already taken place, which usually consists of damage control. As one can imagine, this approach can be overwhelming and requires managers to be ready to deploy strategies at any moment.

ERM takes a proactive approach by getting in front of this risk before it is able to occur. The proactive method prepares for the current day's potential threats and defines emerging risks that could impact the business long-term.

Disjointed vs Embedded Mindsets

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While almost every business has its own way of managing risks, it tends to be disjointed and difficult to standardize. Some may simply document threats, while others fail to recognize their impacts on different strategies. Either way, these methods do not bring much value to the overall risk management and make it easy for risks to slip through the cracks.

An advanced ERM procedure embeds a risk mitigation mindset in the workplace by utilizing identification, assessment, and management processes. This means that each employee is able to evaluate threats and determine how they might impact various business elements, such as finances, reputation, and strategy.

By changing the work culture to prioritize risk management, companies can improve their overall decision-making.

Standardized vs Nuanced Skills

Similar to the workplace mindset, specific skills and procedures should be standardized rather than randomized.

Standardizing ERM is relatively straightforward, as there are several international standards that involve risk management, including-

  • ISO 27000 IT
  • ISO 18000 Health and Safety
  • ISO 22000 Food Safety
  • ISO 50001 Energy
  • ISO 13485 Medical Equipment

By following well-known standards, all businesses within the supply chain can ensure that they are on the same page and remain compliant.

7 Key Components to an ERM Plan

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Creating an ERM framework requires businesses to take an honest look at their internal operations to determine their ability to mitigate risks. In order to do this, companies need to outline their-

1. Business Strategy and Risk Coverage

Before an enterprise is able to assess its risk appetite, it must first layout the business strategies to define the objectives, goals, and processes. This is when stakeholders need to determine what they want to achieve, regarding-

  • Market penetration
  • Product development
  • Sales
  • Profitability
  • Expansion

From here, the company can evaluate the risk management they have in place to mitigate these threats. Regardless of how extensive a strategy may be, every business is exposed to risks, such as-

  • Credit
  • Liquidity
  • Reputation
  • Market
  • Operational
  • Compliance
  • Financial

2. Risk Appetite

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Risk appetite is the amount of risk a business is willing and able to withstand while striving towards a financial target.

While risk appetite and risk tolerance are often used interchangeably, they focus on different work scopes-

  • Risk Appetite focuses on how much a business can accept while pursuing a long-term goal.
  • Risk Tolerance focuses on the day-to-day operational limits that are based on the company's overall risk appetite.

Understanding the difference between these terms is essential for accurate business planning and strategizing.

3. Culture and Policies

A workplace's culture is truly defined by what employees think and do behind-the-scenes when they are not being monitored. Therefore, if a business has competent workers but a poor culture, they will generally experience inadequate risk management.

Company policies should define their risk appetite so employees and stakeholders alike understand what they are able to endure. In other words, risk management policies help businesses collectively manage their governance activities.

4. Risk Data and Management

Businesses can only mitigate threats through in-depth analyses of their risk profile. This enables executives to build an infrastructure that gathers, aggregates, and evaluates risk data so every department is on the same page.

This ERM stage is typically the most challenging as it requires extensive knowledge of the ins and outs of the business's operations, staff, systems, and data interfaces. Companies must establish a robust data management system that can integrate with existing software in order to govern activities.

5. Control Environment

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Internal control is critical for adequate risk management since companies that have poor governance practices are unable to limit their exposure to threats. The elements involved in an internal control environment include-

  • Policies
  • Work culture
  • Preventative and detective controls
  • Scenario generation

By properly balancing these tools, managers can decrease the severity of disruptions to an adaptable level, mitigating residual risks.

6. Measurement and Evaluation

At this point, businesses should have a portfolio of risks assembled, from financial to operational, enabling them to actively monitor threats. By keeping this in a centralized platform, management can redesignate their time, energy, and resources in real-time in response to emerging hazards.

Many companies evaluate and score threats by assigning colors.

  • Red refers to the most dangerous threat
  • Yellow signals emerging risks
  • Green indicates mitigated threats

This criterion can be altered based on the type of business and mitigation plan, but ultimately is used to help managers prioritize hazards.

7. Scenario Planning

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Finally, businesses can use their established ERM framework to-

  • Identify risks
  • Score risks
  • Prioritize risks
  • Run scenarios
  • Allocate resources

By running scenario tests on various types of threats, companies can determine if their ERM practices are adequate to perform in real life. These tests are also great for defining potential weaknesses that could lead to residual or undetected threats.