Enterprise Risk Management (ERM) in business includes the methods and processes used by businesses to manage risks and seize opportunities related to the achievement of their objectives. ERM provides a framework for risk management, which typically involves identifying particular events or circumstances relevant to the business’s objectives (risks and opportunities), assessing them in terms of likelihood and magnitude of impact, determining a response strategy, and monitoring progress.
The risk management process involves:
- Establishing context – This includes an understanding of the current conditions in which the business operates on an internal, external and risk management context.
- Identifying risks – This includes the documentation of the material threats to the business’s achievement of its objectives.
- Analysing/quantifying risks – What is the probability of each material risk?
- Integrating risks – This includes the aggregation of all risk distributions.
- Prioritising risks – What risks are the most harmful to the business?
- Treating risks – This includes the development of strategies for controlling and minimising the various risks.
- Monitoring and reviewing – This includes the continual measurement and monitoring of the risk environment and the performance of the risk management strategies.
An example of the risk management process for a small to medium sized Australia iron ore producer in January 2013 should have involved:
- Establishing context – The current market price of iron ore is $US150 per ton and production costs an average $US100 per ton.
- Identify risks – What happens to the company if the iron ore price drops to $US80 or $US50 per ton?
- Quantifying risks – How likely or possible is $US50 per ton iron ore price? The December 2005 iron ore price was only $US28 per ton, so in hindsight very possible.
- Prioritising risk – If the iron ore price drops to $US50 per ton the company goes into liquidation. (At this point in time [January 2016] the iron ore price is $US40 per ton).
- Treating risk – Possible strategies include: (1) Raising capital and paying off all the company debt. (2) Hedging the iron ore contracts. (3) Cutting costs to reduce the break-even production cost per ton. (4) Building a cash buffer, and (5) Diversifying the company into other products.
Risk is an essential part of any business and if properly managed drives growth and opportunity. If ignored and mismanaged, can destroy a business almost overnight.