What is Risk Control?
The term “risk control” refers to the set of techniques that are used by firms for evaluating potential losses and taking action to either partly reduce or entirely eliminate these threats. This method uses the findings of the risk assessment process, which involves the identification of the potential risk factors within a company’s operational setup. These risks can be related to technical & non-technical aspects of the business, fiscal policies, or anything that can adversely impact the well-being of the company.
Explanation of Risk Control
Businesses, in general, face new challenges every day, which can be due to some hurdles, competition, and any other potential risks. It is a methodical approach that businesses use with the aim of identifying, assessing, and preparing for any such dangers, which can be either physical or symbolic and may affect the firm’s operations and objectives. In this way, the firm can successfully manage the business matters in order to ensure maximization of the shareholders’ return.
How does Risk Control Work?
Any risk control method comprises the following step by step approach:
- Timely analyze the current business activities to identify any potential risks
- Takemitigating actions to either reduce or eliminate these risks
- Re-assess the business activities to ensure successful implementation of this measures
Let us take the example of two companies, company 1 and company 2, having similar production units in which they manufacture shoes. Company 1 has a proper team for assessing risk and controlling their impact, whereas Company 2 doesn’t have any such team and it manages the risks as and when they occur.
In 2019, the team of company 1 informed the management about a possible shortage of raw material in the near term that may disrupt production for a month resulting in a loss of $30 million if not acted upon. on the other hand, company 2 is unaware of this risk. based on the risk assessment, company 1 created sufficient stock of raw material and sailed through the shortage period, while company 2 incurred losses upto $25 million. now, company 2 won’t have booked such losses if it had a proper control team just like company 1. This example shows the importance of risk control.
Types of Risk Control
There are three major types. They are detective, preventative, and corrective.
- Detective Risk Control: These control measures are implemented only after the detection of the discretionary event. Examples of detective risk control include an internal audit of financial reporting, review of financial statements, reconciliations of physical inventories, etc.
- Preventative Risk Control: These control measures are put in place in order to stop a potential risk event from happening. For instance, all financial models have a built-in check for the balance sheet to avoid a mismatch of total assets and total liabilities.
- Corrective Risk Control: These control measures are implemented after the discovery of a problem by detective risk control. The aim is to avoid repetition of the same mistake again in the future. Examples of corrective risk control include disciplinary action, software patches, reports filed, etc.
Techniques of Risk Control
There are six main techniques that can be used. They are avoidance, loss prevention, loss reduction, separation, duplication, and diversification.
- Avoidance: This control technique is used to avert a risk entirely and if implemented successfully, then there is almost zero chance of incurring losses due to that particular risk.
- Loss Prevention: This control technique doesn’t eliminate the risk but rather prevents the expected losses. In other words, this technique accepts the risk instead of avoiding it completely and then attempts to prevent the losses because of it.
- Loss Reduction: This technique accepts both the risk and the loss that might occur because of it. It simply attempts to minimize the losses in case the risk event occurs.
- Separation: This control technique involves the spreading of key assets. In this way, it ensures that if some catastrophic event takes place at one location, not all assets will be impacted simultaneously.
- Duplication: This technique involves the creation of a backup plan. It is primarily practiced in technology-based firms.
- Diversification: This control technique involves the allocation of available resources across multiple lines of a business. In such a scenario, any calamitous event in one of the business segments doesn’t impact the entire firm’s operation.
How Does Risk Control Help Firm?
If a firm can successfully analyze and control the ill-effects of the potential risks, then it can easily sail through any adverse situation that may take place in the future. In effect, by controlling the risks the firm can restrict the losses to a minimum which in turn will result in maximization of returns for the shareholders of the company and add value to the market share of the firm.
Every business operates in an environment that comprises various types of risks. Some of these risks may be avoided, while others have to be accepted and controlled in order to abate their impact on the business. Timely analysis of potential risks and implementation of adequate measures to mitigate such risks can help an organization achieve its business objectives and goals, which provides the ability to sustain in the event of any such risk and indirectly add to its market value. As such, most of the big and reputed organizations across the global have an established team for analyzing and controlling such business risks.
So, it can be seen that risk control measures play a vital role in the success of a business firm, which means the achievement of its business objectives and goals while running the business activities according to plan. In other words, it can be said that businesses at any level requires proper management of the potential business risks in order to achieve their objectives.
This is a guide to Risk Control. Here we also discuss the introduction and how does risk control work? along with types and examples. You may also have a look at the following articles to learn more –