UK Accounting Glossary
Risk management, in the context of economics, is also known as financial risk management. It is defined as the means by which economic value is created in a firm to overcome financial risks. Risks are countered by implementing financial instruments. Some of the common financial risks include market risk, credit risk, liquidity, volatility and inflation risks.
All organizations, big and small, are exposed to certain risks characteristic of financial markets. These financial risks make an impact on these firms, either indirectly or directly. When exposed to the financial market, there is always a chance of making a profit or undergoing a loss. Financial risks arise out of innumerable monetary transactions like loans, purchases, sales and investments. At times legal processes, takeovers, debt financing and mergers can also lead to such risks.
Financial risk management deals with the ways in which an organization develops its management strategies keeping pace with its policies and internal priorities. The process includes identifying risks, fixing a certain level of risk tolerance, executing the necessary management strategies and to determine, monitor and report accordingly. The three ways in which financial risk management is done include accepting the financial risks by default, identification of the section of exposures that can be hedged and finally hedging of all such exposures.
Risk management is a systematic approach to minimizing an organization’s exposure to risk. A risk management system includes various policies, procedures and practices that work in unison to identify, analyze, evaluate, address and monitor risk. Risk management information is used along with other corporate information, such as feasibility, to arrive at a risk management decision. Transferring risk to another party, lessening the negative effect of risk and avoiding risk altogether are considered risk management strategies.
Examples of risk management practices include purchasing insurance, installing security systems, maintaining cash reserves and diversification. Traditional risk management works to reduce vulnerabilities that are associated with accidents, deaths and lawsuits, among others. Financial risk management focuses on minimizing risks through the use of financial tools and instruments including various trading techniques and financial analysis. Many large corporations employ teams of risk management personnel.
Establishment of context may be broken down into the following steps:
Following are most often used methods of identification:
Potential risk treatments may be further subdivided into the following:
Creation and implementation of a proper risk management plan is also an integral part of risk management procedures. It is also important to review and evaluate the plan from time to time so that a risk management plan could be made more effective.
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This glossary post was last updated: 6th February 2020.