Finance departments deal with risk on a near-daily basis. In the past, many types of risk could be only estimated or theorized before they developed into more urgent scenarios presenting material risk to an organization. Finance leaders could speculate on various threats facing the company at any given point in time, but they couldn’t effectively monitor and analyze risk in real time, which meant more potential consequences.
An effective financial risk assessment process requires established policies and protocols to identify, evaluate, and address financial risks facing the company. These risks can run the gamut from liquidity risks and vendor relationship risks to risks related to evolving production costs, consumer demands, or government regulations.
Fortunately, a new wave of business intelligence tools offers predictive modeling and real-time data, turning the financial risk assessment process into an ongoing—and more accurate—strategy for making business decisions that minimize your material risk.
Organizations should conduct financial risk assessments on an annual, if not more frequent, basis, but it’s also smart to conduct this assessment prior to making any new financial deals or acquisitions. If you’re in the process of building a risk assessment protocol for your business, here are five steps to include in your plan.
1. Identify the Risk
Every business will face different types of risk depending on its cash-flow situation, its geographic location, its industry, its reserve capital, its vendor relationships, and so forth.
Finance departments should have a general awareness of the types of risk they’re likely to face in the course of doing business. When a potentially risky situation arises, leadership needs to order a risk assessment to evaluate the potential risk a business decision represents.
2. Assess and Document the Risk
The assessment of a risk will depend on the specific risk faced. If you’re concerned about the financial stability of an important vendor relationship, gather information about the vendor’s performance history, its current financial information, and possible alternative vendors that could offer the same or a similar service while exposing your business to less risk.
When assessing risk, your primary goal should be determining the worst-case scenario, the likelihood of that scenario coming to pass, and the process your business would require to recover from the potential material losses. In some cases, the risk may be significant enough that it could thrust your company’s solvency into question.
Develop a scoring rubric to document risk in each isolated instance, and use that scoring information to determine your next steps in risk management.
3. Delegate Management Steps
When risk management steps are required, assign one or more members of your team to handle risk containment efforts. The more involved the process of containment is, the more human capital you will need to assign to this process.
Having a point person in charge of risk management will improve accountability and make it easier to coordinate containment efforts.
4. Take Action
If you have risk management procedures in place, the process should be fairly straightforward. Finance team members assigned to risk containment should execute those procedures and provide updates on the process.
If the risk is related to future liquidity, for example, your team members may start by monitoring cash flow to ensure a new financial venture isn’t on track to create a liquidity issue. If the potential for this problem does develop, your team should take action to mitigate this risk by adjusting cash-flow management before the risk results in material losses.
5. Monitor/Maintain Progress
As risk management procedures play out, assigned team members should keep a close eye on the situation to monitor for any developments that require further action.
Even after the risk is believed to be contained, periodic reviews will ensure that new complications or variables aren’t raising the level of risk resulting from the original situation. This monitoring can also help you identify new risks before they develop into urgent threats to your business.
When you establish a financial risk assessment process at your company, your finance team will have a better understanding of the potential risks faced with any business decision. As a result, your organization will be better equipped to weigh the risk and reward of any potential action while emphasizing the importance of maintaining a secure control environment.