What Does it Mean to Accept Risk?
To accept risk is a risk management strategy where the identified risk is considered acceptable enough that no expense or effort is made trying to limit or avoid it.
Risk acceptance occurs when a business or individual decides that the potential loss from risk is not great enough to justify spending money or effort to avoid it. To accept risk, or risk retention, is an aspect of risk management commonly found in business, investment, and finance.
Risk acceptance holds that occasional and minor risks are worth accepting. That means those risks that do not have the potential to be catastrophic or otherwise prohibitively expensive. The strategy is to deal with any minor difficulties when they emerge. Such a trade-off is a useful tool in prioritization and budgeting.
Whether or not to Accept Risk – A Closer Look
Most firms eventually discover that they have more risks than they can manage, mitigate, or prevent. This is particularly true given the limited resources at their disposal. As a result, organizations must strike a balance between the potential costs of a problem caused by a known risk and the cost of preventing or otherwise dealing with it. Any and all risks that are not accepted, transferred, or avoided are said to be retained risks.
Many businesses use risk management to evaluate and categorize the probability and potential impact of financial distress. This helps to better monitor and prepare. However, managers quickly discover that their organizations face almost limitless business hazards. Many of these can be avoided or reduced depending on the level of effort and resources invested. As a result, organizations attempt to strike a balance between the financial repercussions and the cost of managing them.
Types of Risk
Risk acceptance is not really a mitigation strategy. This is because accepting a risk does not reduce its effect. Nevertheless, risk acceptance is a legitimate option in risk management. However, some risks are more dangerous than others. Below are the type of risks that every business owner must be aware of.
Economic Risk
As markets change, the economy is continuously shifting. Some favorable changes are beneficial to the economy and contribute to brisk purchasing situations. However, bad economic events might lower sales and severely impact revenue. It is critical to monitor changes and trends in order to predict and prepare for an economic slump. To mitigate economic risk, conserve as much money as possible to maintain a consistent cash flow. As part of your business plan, maintain a tight budget with low overhead during all economic cycles.
Compliance Risk
Business owners are subject to a plethora of laws and regulations with which they must comply. Recent data protection and payment processing compliance, for example, may impact certain areas of your operation. Maintaining a thorough understanding of applicable regulations from federal authorities as well as state and municipal agencies can help reduce compliance risks.
Security and Fraud Risk
More people disclose personal data via the internet and mobile platforms. As a result, the potential for hacking continues to grow. Data breaches, identity theft, and payment fraud show how this type of risk is becoming more prevalent for firms. This danger can jeopardize the trust and reputation of a firm. Moreover, it also makes a corporation financially accountable for any data breaches or fraud. In response, firms must focus on security solutions, fraud detection tools, and staff and customer education. Learning to recognize possible security concerns will help to achieve effective enterprise risk management.
Financial Risk
Financial risk is a broad category. This business risk could involve client credit or your own company’s debt load. Variations in interest rates can also pose a risk. Making changes to your business strategy will assist you to prevent damaging your cash flow or incurring an unanticipated loss. Keep debt to a minimum and devise a plan to begin reducing your debt load as soon as possible. If you rely solely on one or two clients for all of your income, your financial risk could be enormous. Particularly if one or both stop using your services. Begin selling your services to diversify your clientele. This can diversify your revenue so that the loss of one customer does not damage your bottom line.
Reputation Risk
There has always been the risk that an unhappy customer, product failure, negative press, or lawsuit can adversely impact a company’s brand reputation. However, social media has amplified the speed and scope of reputation risk. Just one negative tweet or bad review can decrease your customer following and cause revenue to plummet. To prepare for this risk, leverage reputation management strategies to regularly monitor what others are saying about the company online and offline. Be ready to respond to those comments and help address any concerns immediately. Keep quality top of mind to avoid lawsuits and product failures that can also damage your company’s reputation.
Operational Risk
This type of business risk might occur internally, externally, or as a result of a mix of causes. Something unforeseen could occur, causing you to lose a core continuity. It might be a natural calamity or a fire that damages or destroys your physical business. It could also be a server outage caused by technical issues, humans, or a power loss. Many operational risks are also tied to people. An employee may make blunders that cost him or her time and money. These operational risks, whether caused by people or processes, can have a negative impact on your firm. The impact might be felt negatively in terms of money, time, and reputation. Each of these potential operational hazards should be addressed through training and a business continuity plan. Then, set up a backup system or proactive efforts to guarantee that activities are not disrupted.
Competition Risk
In general, most companies are aware that there is always some rivalry between their industry competitors. However, it is easy to overlook obvious things other firms are doing that may appeal to your customers. Even industry leaders can become comfortable and complacent. As a result, they do not seek ways to pivot or make continuous changes. Customers may be lost as a result of increased competition and a refusal to change. Enterprise risk management entails a company’s continuous evaluation of its performance. It should involve constant refinement of its strategy. Ultimately, this should include the maintenance of strong, interactive ties with its audience and consumers. (Source: americanexpress.com)
Accept Risk vs Other Alternatives
There are four primary ways to handle or manage risk, no matter the industry:
- Accept risk – Some dangers may unavoidable, yet the consequences remain tolerable. In some circumstances, it is less expensive to leave an asset unprotected owing to a specific danger. It may not make economic sense to expend the labor and money required to safeguard it. However, this cannot be a hasty decision. All alternatives should be evaluated before blindly taking on the risk.
- Avoid risk – This usually entails the ability to change plans to hedge or eliminate risk. Depending upon the circumstances, you may need to change the project scope, modify project plans, hire additional resources, or adopt different technical solutions. Avoidance can be costly, but it may be the only way to save a project. Risk avoidance involves eliminating any activity that poses potential loss. Managers achieve risk avoidance through policy and procedures, implementation of technologies, as well as training and education.
- Transfer – Also known as risk-sharing. Insurance policies effectively transfer risk from the insured to the insurer. Risk transfer involves allocating risk from one party to another on a contractual basis. The responsibility is allocated to the party with the capability to control and share the risk. The method is commonly used by insurance companies. This method is most applicable when projects include multiple parties who are capable and willing to share the risk.
- Mitigate – Limit the impact of risk so that if a problem occurs it will be easier to fix. Risk mitigation involves limiting the consequences of a risk to deal with as it occurs. The strategy is commonly achieved through hedging.
Whether or not To Accept Risk – Example
For example, consider a consumer electronics supplier who depends on a single supplier for certain key components. Without these specialized devices, production will be impacted and revenue will decline. Management has looked into qualifying an additional supplier, but the process will be prohibitive in terms of time and resources. Research shows that the probability of a major supply disruption with the current supplier has a likelihood of less than 1%. As a result, management decides to accept the current risk and delay qualifying another supplier.
There is no benefit in spending $50,000 to avoid a $5,000 risk. In cases where the cost outweighs the benefit, it can be more prudent to accept a risk rather than spend time or money mitigating it.
You Can Accept Risk, But Plan
Although you will never be able to completely eliminate business risk, proactively planning for it can help. Awareness is key in helping you save money and time while protecting the trust, reputation, and customer base you’ve worked so hard to achieve.
Final Words
Small businesses frequently argue that they cannot afford to avoid, reduce, or transfer risk. As a result, they accept risk as a given. This is an incorrect and narrow viewpoint. Further, it should not be the starting point for risk planning. Risk acceptance should be weighed against the other possibilities. Therefore, it is necessary to identify the consequences, suitable actions, and costs of various mitigation techniques. Risk acceptance often appears to be the cheapest option in the short term. However, it t is frequently the most expensive option in the long run if an unexpected or adverse event occurs.
Up Next: Auditable Meaning in Accounting vs Software Applications
Auditable Meaning in Accounting and Finance: The ability of an auditor to successfully conduct a comprehensive examination of a client’s financial records, files, & data.
A financial audit is an official examination of an individual’s or organization’s financial statements and records. Typically, an audit is conducted by an objective and independent body. The purpose is to verify and confirm the reported information is fair and accurate.
Auditable meaning in Software Applications and Programming: The ability to gather data for fault removal and debugging purposes. The data gathering method for such processes is referred to as auditing. Software that consistently captures such data is referred to as auditable.
