In today’s modern threat landscape, compliance risk, cybersecurity and fraud risk, and even climate change risk can have a significant impact on your company’s bottom line. External risk events, such as the COVID-19 pandemic, point to the increasing need for businesses to develop a risk assessment plan that helps them execute strategy and achieve objectives.
Although you’ll never be able to eliminate business risk completely, prevention is truly the best insurance against loss. By defining, assessing, and analyzing risks with a risk assessment matrix, you’ll cultivate a solid understanding of your risk environment and manage risks before they occur — saving your company money, time, and resources.
In this article, we break down how to create a risk assessment matrix in four easy steps — and how to take care of your risk matrix so that you can continue to identify emerging threats.
What Is a Risk Assessment Matrix?
A risk assessment matrix, also known as a Probability and Severity risk matrix, is a visual tool that depicts the potential risks affecting a business. The risk matrix is based on two intersecting factors: the likelihood that the risk event will occur, and the potential impact that the risk event will have on the business. In other words, it’s a tool that helps you visualize the probability vs. the severity of a potential risk.
Depending on likelihood and severity, risks can be categorized as high, moderate, or low. As part of the risk management process, companies use risk matrices to help them prioritize different risks and develop an appropriate mitigation strategy.
Take the risks of the coronavirus pandemic to biotech healthcare enterprises as a risk assessment matrix example. Supply-chain disruption might be classified as a high-level risk — an event that has a high probability of occurring and a significant impact on the business. The need for first aid or minor medical treatment for staff, on the other hand, is a low-level risk — it might occur but will have negligible impact if it does.
Still, even unusual risk events can have a significant impact on business outcomes. While it’s uncommon in biotech, a fatal workplace injury would be high impact and reportable to OHSA. That’s why it’s so critical to have an accurate picture of all the potential risks your business faces, so that you can assess their impact and create a successful risk management plan.
How Does the Risk Assessment Matrix Work?
Risks come in many forms: strategic, operational, financial, and external. The risk assessment matrix works by presenting various risks as a chart, color-coded by severity: high risks in red, moderate risks in yellow, and low risks in green. Every risk matrix also has two axes: one that measures likelihood, and another that measures impact.
Likely risk events may have a 61 to 90 percent chance of occurring, while highly unlikely events are extremely rare, with a less than 10 percent chance of occurring. Depending on the business and their risk appetite, an insignificant impact may cause a negligible amount of damage — such as a loss of less than $1K — while a catastrophic impact might create losses of $1M or more.
Whatever the parameters you set for the risk event’s likelihood and impact, the risk assessment matrix provides a quick snapshot of the threat landscape. By visualizing the threat landscape in this way, audit, risk, and compliance professionals can more easily determine how to minimize what Deloitte calls value killers, loss events that can have a substantial impact on the company.
Why Is the Risk Assessment Matrix Important?
A risk assessment matrix can help businesses cultivate a solid understanding of the risk environment, helping them manage risks before they occur. If 2020 showed us anything, it’s that the magnitude and complexity of business risks continue to grow. As outlined in KPMG’s Internal Audit: Key risk areas for 2021, the ongoing COVID-19 pandemic, unprecedented natural disasters, and global civil unrest set the stage for a new normal that will impact businesses for years to come. Now more than ever, companies must meet the challenges of the present — and the future — by identifying, analyzing, and mitigating risks quickly.
The risk assessment matrix is a crucial tool in risk management for three reasons:
1. Easy Prioritization of Risks
All risks aren’t equal. A risk matrix allows you to prioritize the most severe risks your company faces. As mentioned previously, having a comprehensive view of today’s modern threat landscape is critical for preventing value losses. All companies must take on some level of risk in order to succeed, but calculated risks based on a robust risk analysis will help businesses take on risks in a way that helps achieve objectives.
While it may be tempting to allocate resources to all potential business risks, some operational risks — such as major reputational damage due to breach of private data, or an excessive increase in operation costs due to natural catastrophe — must be prioritized before others.
By color-coding these risks in a risk assessment matrix, audit, risk, and compliance professionals can identify the most pressing threats to the business and plan for them.
2. Targeted Strategy for Managing Risks
Just as all risks aren’t equal, all risks don’t carry the same impact. With its prioritization of the most pressing threats, the risk assessment matrix enables professionals to craft a targeted strategy for managing high risk events. Focusing your attention and resources on the highest risks will benefit your overall business strategy, since these risks have the biggest impact and can pose the greatest value losses.
From a project management perspective, for example, a brief bottleneck in the project workflow would create little impact, provided there was enough float built in at the beginning of the project design. A cost risk that significantly escalates the project cost would have a severe impact, however, and requires a targeted management plan.
As any project manager knows, Murphy’s law is inevitable: what can go wrong, will go wrong. Appropriately planning for cost risk due to factors like scope creep will ensure that a project is successful. With the help of the risk matrix, planning for Murphy’s law becomes a lot easier.
3. Real-Time View of the Evolving Risk Environment
Audit, risk, and compliance professionals know that risks can be emergent and recurring. The risk assessment matrix enables you to identify specific types of risk, their probability and severity, and maintain a real-time view of the evolving risk environment.
Though emergent risks are by definition unknowable, businesses can identify areas of vulnerability at the strategic level by strengthening their enterprise risk management processes. By looking at early warning signs or trigger events that indicate something is amiss, companies can maintain business continuity in an increasingly dynamic and complex risk landscape.
Strategic risk assessment tools like the risk matrix also enable companies to track patterns of risk — threats that are likely to reoccur and therefore require a year-over-year mitigation strategy.
How to Make a Risk Assessment Matrix?
Although the magnitude and complexity of business risks continue to grow, creating a risk assessment matrix doesn’t have to be a complicated process. There are four basic steps to making a risk assessment matrix:
Step 1: Identify the Risk Landscape
Because the magnitude and complexity of business risks continue to grow, it’s essential that you develop a comprehensive picture of the total risk landscape.
To begin, hold brainstorming sessions with key stakeholders in your organization so that you can mine insights and start generating a list of ideas that will serve as the foundation of your risk assessment matrix. Since risk analysis is subjective, it’s vital to get a wide variety of stakeholder input — doing so minimizes the chances of missing something valuable.
Start your brainstorming session by categorizing risks according to the following criteria:
- Strategic Risk: risks associated with failed business decisions.
- Operational Risk: risks associated with breakdowns in internal processes/procedures.
- Financial Risk: risks associated with financial loss.
- External Risk: risks associated with uncontrollable, non-human sources.
Begin with the highest-level risks related to business functions, such as operations, and then narrow your focus to specific processes within those functions, such as supplier management.
Step 2: Determine the Risk Criteria
After brainstorming risks associated with the larger risk landscape, determine the criteria by which you’ll be evaluating these risks. As mentioned earlier, risk assessment matrices typically use two intersecting criteria:
- Likelihood: the level of probability that the risk will occur.
- Impact: the level of severity that the risk will have.
It’s critical that you achieve consensus on the risk criteria, as this will impact not only the way you calculate your risk matrix, but also the discussions you’ll have on how to mitigate your risks. Accurate measurement is the key to successful risk management!
Step 3: Assess the Risks
Now, assess the risks based on your risk criteria, providing a qualitative risk analysis according to a pre-defined scale. Most organizations use the following, three-part scale to assess severity:
- High risk
- Medium risk
- Low risk
A more granular approach could prove useful as well. Expanding the scale to a “1-5” rating, where 1 is extremely low-risk and 5 is extremely high-risk, would provide more insight on levels of severity and help companies allocate resources more efficiently.
Step 4: Prioritize the Risks
Finally, compare the different levels of risk (high, medium, or low) to the risk criteria (likelihood and impact). Prioritize those risks that pose the highest likelihood and impact, and create a risk assessment plan that effectively mitigates them.
Keep in mind that the risk landscape is constantly evolving, and the risk assessment matrix should be updated multiple times a year in order to reflect the changing risk environment. Failure to update the risk assessment strategy could result in missing emerging risks that may disrupt business objectives and continuity.
How to Determine the Likelihood of a Risk Occurring?
An essential component of the risk assessment matrix is determining the likelihood of a risk occurring. After all, if you incorrectly determine the probability of a risk, you’ll be missing a critical opportunity to prevent unnecessary value losses.
Most companies use the following five categories to determine the likelihood of a risk event:
1: Highly Likely. Risks in the highly likely category are almost certain to occur. Typically, risks with 91 percent or more likelihood fall into this category.
2: Likely. A likely risk has a 61-90 percent chance of occurring. These risks need regular attention, as they are bound to reoccur and therefore require a consistent mitigation strategy.
3: Possible. Possible risks may happen about half the time — they have a 41-60 percent chance of occurring and need attention.
4: Unlikely. Risks in the unlikely category have a relatively low chance of occurring — 11 to 40 percent. But they may still affect your business, so it’s a good idea to keep an eye on them.
5: Highly Unlikely. Highly unlikely risks are exactly as they sound, with a less than 10 percent chance of occurring.
How to Take Care of Your Risk Assessment Matrix
Since the modern threat landscape is constantly changing, your risk assessment matrix needs consistent attention and iteration to meet the challenges of today and tomorrow. Whether your business needs to establish a solid enterprise risk management program or strengthen internal controls to prevent fraud, risks events, both external and internal, will require regular assessment in order to determine their likelihood and impact successfully.
As all audit, risk, and compliance professionals know, the only constant is change.
With the help of the risk assessment matrix, you’ll be more easily equipped to identify emerging threats and properly allocate resources to mitigate their impact.
Ready to Reduce the Likelihood of Risks?
Using the risk assessment matrix for risk management will reduce not only the likelihood of the risks your business faces, but also the magnitude of their impact on business operations. Effectively managing risk has always been critical for success in any business endeavor, but never more so than today. An important part of your risk strategy should involve managing your company’s risks by using integrated risk management software that facilitates collaboration and risk visibility to increase the effectiveness of your risk management programs.
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