Risk Management: Definition, Benefits, Objectives, Principles and Steps

Risk management is important to avoid risks that occur in a company. Risk is defined as an unpleasant consequence of an action. Risk is a familiar word and has a negative connotation. For example, if we have a business, but employees are dishonest and like to steal, then there is a risk that the business will suffer losses (unpleasant events).

In a company where there is certainly business activity, a risk must be managed as well as possible, especially in the midst of a pandemic situation like today. Because risks can appear at any time and vary. It takes a method or way to anticipate it. Let’s study carefully about the following risk management.

1. Definition of Risk Management

Risk is related to uncertainty, this occurs because of a lack of information about what will happen. Something that is uncertain can be beneficial or detrimental. As interpreted by (Regan: 2003) that risk is a possibility that causes or implies loss or danger.

Defined by Wideman and Mamduh (2009) that risk is uncertainty that creates a profitable possibility known as opportunity, while uncertainty that causes adverse consequences is known as risk .

Emmaett J Vaughan and Curtis Elliot (1978) state, risk is defined as the chance of loss, the possibility of loss, uncertainty, the dispersion of actual from expected result), the probability that a result is different from the expected (the probability of any outcome different from the expected).

Risk is classified into two by Mamduh Hanafi (2009) , namely: pure risk and speculative risk. Pure risks or commonly called pure risks are risks where the possibility of loss exists but the possibility of profit does not exist. Example: fire, accident, flood, etc. Meanwhile, speculative risk is a risk where we expect losses as well as profits. Example: buying stocks, business ventures, and so on.

In this world, we must face uncertainty. This element of uncertainty often results in a loss. This is a universal trait, almost always present in all aspects of human life. Losses from this element of uncertainty (risk) can be manifested in a variety of activities, both in economic, social and legal activities.

For this reason, in order to overcome all risks that may occur, a process called risk management is needed. Risk management is a management activity carried out at the executive leadership level, namely the activity of finding and systematically analyzing losses that may be faced by a company due to a risk and the most appropriate method for dealing with losses associated with the level of profitability of the company.

Herman Darmawi (2006) states, risk management is an effort to find out, analyze, and control risks in every company activity with the aim of obtaining higher effectiveness and efficiency.

Irham Fahmi (2010 ) defines risk management as a field of knowledge that discusses how an organization or company applies measures in mapping various existing problems by placing various management approaches in a comprehensive and systematic manner.

This risk management is also an application of general management that tries to identify, measure, and handle the causes and effects of uncertainty in an organization or company. Thus, risk management is needed to avoid and minimize risks that will arise or be faced by the company.

In its application in banking, risk management is also used to identify market, operational and bank credit risks which you can learn about in Risk Management 1 book below.

2. Benefits of Risk Management for the Company

The benefits that a company will get if it carries out risk management properly include:

a. Guarantee the achievement of goals

Management in a company uses every good means to achieve its company goals. In an effort to achieve this goal, many things can happen. There are things that can be anticipated in advance, and there are possible uncertain futures. Uncertainty is what creates risk.

The goal will be easier if the obstacles that may occur are known beforehand. Ronny Kountur (2004) says, the success of a company is determined by management’s ability to use various existing resources to achieve company goals. Companies can be successful if they have good goals to achieve.

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Companies that have good risk management will find it easier to achieve their goals compared to companies that do not have good risk management.

b. Minimizes the possibility of bankruptcy

All companies have the possibility of bankruptcy or bankruptcy. The risk of bankruptcy can happen to anyone at any time. No one can guarantee that a company will not go bankrupt.

Companies that implement risk management properly will be able to handle various adverse possibilities that will occur to their company. This can minimize the possibility of loss and the existence of the company can be maintained.

c. Increase company profits

Good and regular risk management can certainly increase company profits. One of the benefits of risk management is that it can minimize losses so that the profits will be greater.

By handling good risk management, all possible losses that could befall the company can be kept to a minimum so that costs are reduced and the profit that goes to the company can be increased. This should be one indicator of the successful implementation of risk management within a company.

d. Provides job security

Managers must have the ability to understand, analyze, and handle risk. Managers who can handle risk well can help save the company.

If the company that the manager handles can avoid losses, then it is certain that the company will experience progress and the manager’s career will also progress.

Ronny Kountur (2004) once said that many companies were not willing to hire managers from companies that had previously been bankrupt or did not perform well while being led by that manager. Reluctance to hire underperforming managers is sometimes not due to inexperience, but possibly due to a lack of understanding in dealing with contingencies or risks.

In better understanding the benefits of risk management and integrating it with other management systems in the company, the ISO 31000:2018 Based Risk Management book: A Guide for Risk Leaders and Risk Practitioners is here for you.

3. Objectives of Risk Management

The purpose of risk management is to ensure that a company or organization can understand, measure and monitor the various types of risks that occur and also ensure that the policies that have been made can control the various types of risks that exist. In order for the implementation to run smoothly, it is necessary to have support in developing risk management policies and guidelines in accordance with the conditions of the company.

The purpose of risk management is generally used as a basis to be able to predict the hazards or unpleasant things that will be faced with careful calculations and careful consideration of various information in advance to avoid things that are not desirable.

In particular, the objectives of risk management are:
a. Provide information regarding risks to regulators.
b. Minimizing losses from various uncontrolled risks.
c. So that the company stays alive with continuous development.
d. Cost efficient and effective risk management.
e. Gives a sense of security.
f. So that the company’s income is stable and able to provide satisfaction for owners and other parties.

To achieve its objectives, there is a risk management process that starts from identification, measurement, to handling which is discussed in the book Easy to Understand Enterprise Risk Management which is used to achieve this goal.

4. Principles of Risk Management

Principles in risk management that need to be considered include:

a. Formulation of goals

The clarity of the company’s vision and mission serves as a guideline for determining rational steps and strategies that must be taken, one of which is the goal to be achieved in managing corporate risk through general risk anticipation measures aimed at avoiding all forms of waste.

b. Unity of direction

In carrying out an activity within the company, it must have the same goals as those directed by the leadership. In the book of management principles it is said, an employee who works in one section only receives instructions regarding certain activities from a section head who is his superior.

c. Division of labor and delegation of authority

Division of work and delegation of authority in a company needs to be done so that each unit clearly knows the authority and responsibility it carries. The purpose of the delegation of authority is to achieve maximum results as desired by delegating some of the tasks to subordinates.

d. Coordination

Coordination is one of the management functions or the process of integrating, synchronizing and simplifying the implementation of separate tasks on an ongoing basis to achieve goals effectively and efficiently. With coordination, it is hoped that there will be no overlapping work. Without coordination, it is difficult to obtain effective and efficient company goals.

e. Supervision

With the principle of supervision, it can be known about the results that have been achieved. Supervision can function to measure how far the results that have been achieved are in accordance with what has been planned. Supervision must be carried out to prevent abuse of authority.

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5. Various Forms of Risk

a. Risk nature of business

Various types of businesses contain risks that are different from one another. Initiating businesses that have never been carried out before have a high risk. This is due to a lack of experience.

b. Geographic risk

Geographic risk is closely related to natural disasters that often occur in certain business locations. For example, floods, fires in plantation businesses, and others.

c. Political risk

Political risk also affects a business. Unclear political policies can cause business failure. Therefore, an analysis of the political stability of a region or country is sufficient to provide input on predicting the success of a business in the future.

d. Uncertainty risk

The uncertainty factor will lead to speculation and speculation will carry a high risk, because everything cannot be planned well in advance.

e. Competition risk

Competition risk can take the form of competition among companies within the same industry. To win the competition, of course, marketing management is required to carefully take into account the overall analysis of strengths and weaknesses.

We can see this in one example, namely banking, where there are often risks and to study this, the Bank Risk Management Strategy book was made by the Indonesian Bankers Association.

6. Risk Management Measures

The steps or processes that are usually carried out in an effort to deal with a risk (risk management process) are very dependent on the basic concepts adopted. To make a good plan to avoid the risks faced by the company, several steps must be taken, including:

a. Identification of company risks

Risk identification can be done with the help of using a checklist. In a company, a systematic method is needed to explore all aspects of a company. The methods that can be used are:

1). Risk analysis questionnaire (risk analysis questionnaire)

The risk manager needs to ensure that the required information regarding the company’s assets and operations is not forgotten.

2). Financial reporting method

This method is carried out by analyzing financial statements, namely balance sheets, profit and loss statements , and other financial records. The risk manager can identify all the risks related to the company’s assets, debts and personnel. Each estimate is analyzed in depth with regard to the possible losses that can occur from each estimate.

3). Flow map method

This method will describe the entire series of business operations starting from input to output. A checklist of potential losses is used for the operations shown in the flow map so as to determine the losses faced by the company concerned.

4). On-the-spot inspection method

This method is used to carry out direct inspections at places where company activities are carried out. The risk manager’s observation can produce results regarding the realities on the ground so that it is useful for risk management.

5). Interact with external parties

Outside parties can be interpreted as having relationships with individuals or other companies. Especially those who can assist the company in dealing with risks such as legal advisers, accountants, management consultants, and others. They can assist in developing an identification of potential losses.

6). Statistical record of past losses

These records can be used for performance evaluation. Performance that has the potential to cause losses needs to be monitored and refined, such as: production quality, service quality, and others.

7). Environmental analysis

This step is very necessary in order to determine the conditions that influence the emergence of risks such as consumers, competitors, suppliers, and others. In analyzing each component, important considerations include: the nature of the relationship, their diversity and stability. For example: product sales directly or indirectly, from producers directly to consumers or from producers through wholesalers, new retailers to consumers, and others.

b. Measure risk

Measuring effort is carried out with the aim of knowing the relative importance and obtaining information to determine the right combination of risk management tools to handle. Methods for measuring this risk include:

1) Sensitivity method

The sensitivity method is a way of measuring the impact on exposure as a result of the movement of a risk variable. Measurement with the sensitivity method is widely used because this method is the easiest technical calculation and almost all company analysts and managers have used the sensitivity method for planning decisions. The risk variables analyzed using the sensitivity method include: interest rate risk, exchange rate risk, market risk, credit risk and liquidity risk.

2) The volatility method

The volatility method is a method that shows the magnitude of the possible results around the expected results. The volatility that is often used is the range and standard deviation. The calculation of the standard deviation can use two types of data, namely historical data and forecasted data.

3) Downside risk

Risk can have a positive or negative impact. This risk only measures the potential adverse impact if the risk becomes a reality. Keep in mind, there are conditions where companies can face risks that only have a positive impact, but not only have a negative impact.

c. Risk control

Risk control (risk control) can be done through risk control and risk financing. Risk control can be carried out by avoiding risk