Every decision that you'll ever make in life results in a trade-off. You balance the opportunity cost of the decision with the gain that the decision will produce. You balance the risk of that decision alongside its reward. Risk permeates every decision that humans make, especially in business. Every business that operates in the world has different risks that could compromise its success. Successful companies are those that are able to balance the right amount of risk and implement risk management strategies that mitigate potential loss.

In this article, we'll explain what is risk management in simple terms.

What is Risk Management?

In short, risk management is the art and science of assessing the level of risk that is inherent in a decision as well as strategies to reduce that risk, as well as any potential losses should that risk be realized. Notice the words art and science. Risk management is just as much of a technical discipline as it is one that builds with experience and intuition.

How Does Risk Management Work?

There are several elements that go into risk management. The first such element is assessing the potential risks of a given business or investment decision.

For instance, let's say that a company decides to expand into a new market. The risk is that the market may not be ready for the company's entrance, or that the company's product or service may be ignored by buyers in favor of existing competitor products and services. The first step in risk management is to collect a list of all the risks that could happen. The next step in risk management is to assess the value of the potential risks shortlisted in the first step. Continuing with the previous example, if the company were to fail in the new market, what would be the cost to the business?

How much would the bottom line be affected?

Only when these dollar values are known can risk management become effective.

The last step in risk management is to evaluate the likelihood that the risk will be realized. This can be done in a number of ways, but a common strategy is to look at similar cases. For instance, the company could look back at other markets that they have entered and look at failure rates.

Risk can be mitigated in a number of ways. For instance, by reducing the scale of the operations in the new market, the company can reduce its potential downside should the product or service fail in the new market. Another way to mitigate risk is by purchasing captive insurance, which pays out money in the event that the risk of a business decision is realized.

How Will You Use Risk Management?

Now that you know what is risk management, you can start implementing it in your business and investment decisions. What kind of risk management strategies do you plan to implement?

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