What is Calculated Risk in Business?

Every business decision involves an element of risk. Management’s job is to assess that level of risk as best as possible, and to weigh that risk correctly against the potential rewards.

That risk-versus-reward equation is the basis for taking calculated risks, often referred to as your “risk-adjusted return on investment.”

So how should an executive team approach this process?

Why Risk Management Is Important for Businesses

Risk management is crucial for a business because it gives the management team the tools to identify and handle potential risks effectively. Once a risk is recognized, executives have an easier time reducing its potential harm. Moreover, risk management provides a foundation for making sound decisions.

For any business, evaluating and managing risks is the best way to be prepared for challenges that could hinder progress and growth. By carefully considering how to handle potential threats and creating strategies to address them, businesses improve their chances of succeeding.

Furthermore, a strong risk management strategy can address the most critical risks promptly and decisively. This approach equips management with the necessary information to make informed decisions and assures that the business remains profitable.

How Much Risk Is Too Much?

To answer this, you need to understand your risk appetite. That involves asking several other questions, such as:

• How much risk does your business face?
• How much risk can your business handle?
• How much risk should your business take?
• How much risk does your business want to take?
• How much risk will your business end up taking?
• How much risk is your business currently taking?

There’s no straightforward answer to how much risk is “too much” for your business. It’s a decision that requires careful consideration, considering your personal risk tolerance, your business objectives, and the potential consequences of taking on excessive risk. For example:

• Personal risk tolerance: assess whether you are comfortable with higher risk levels or prefer a more cautious approach.
• Business goals: determine what you want to achieve with your business. If your goal is to make some extra money, but nothing more, you can take on more risk compared to building a large-scale enterprise.
• Consequences of excessive risk: contemplate the possible outcomes if things don’t go as planned. Could you risk losing everything and bringing your business to a halt? Would any potential debt be manageable? Reflect on these questions carefully before making any decisions.

These are all issues management should consider, typically in consultation with your board of directors. You can better understand how much risk is appropriate for your business, and make more informed choices regarding its future.

Risk-Reward Calculation

The risk-reward ratio is a metric that helps business leaders understand the potential profit they can make compared to the amount of money they could lose in a decision. It’s a simple calculation: divide the net profit (reward) by the maximum risk (the amount you could lose).

Using risk calculations for your business

Imagine you’re an IT executive making choices about cybersecurity for your company. You have two options: Solution A costs $100,000, and Solution B costs $150,000. Solution A provides decent security, while Solution B offers stronger protection.

Your IT budget allows for a $120,000 investment. But before you decide, think about the risk-reward ratio in IT investments:

• Objective calculation. The risk-reward ratio is an objective calculation, based on financial numbers and not influenced by emotions or biases.
• Risk tolerance. Different IT executives and organizations have varying levels of risk tolerance. Not everyone feels comfortable with high-risk solutions; what’s OK for one may not be for another.
• Likelihood of success. The risk-reward ratio doesn’t tell you anything about the likelihood of success. It’s like comparing a lottery ticket (high risk, big reward, but unlikely to win) to investing in stocks (lower risk, good reward chances). The probability of a breach may still exist with both solutions, but it could be lower with Solution B due to its comprehensive protection.

In addition to the above, remember that the perceived risk and potential reward of IT solutions may change over time as you gather new information about emerging threats and technology advancements. If you find that the risk-reward ratio becomes unfavorable for a chosen solution due to changing circumstances or evolving security needs, don’t hesitate to reassess and potentially switch to a more suitable option. Always aim for choices where the risk-reward balance is in your favor.

Key considerations for risk-reward calculations in IT investments:

• Safety Nets. Consider using measures such as automated security alerts to prevent big problems if a breach happens.
• Security ROI. Set a target for what you want to achieve with your security investment. This will serve as the point at which you can confidently say your organization’s assets and data are adequately secured.
• Technology selection. Be careful when picking IT solutions. Make sure the solutions match your organization’s security needs and how much risk you’re willing to take.

6 Tips To Limit Risks for Your Business

Below are six tips to limit the risks associated with running a business:

1. Prioritize and rank risks

Prioritize risks based on their likelihood of happening. You can use a simple scale to rank the risks from low risk to high risk based on the probability of an event occurring:

• Most likely to happen
• Some chance of occurrence
• Small chance of occurrence
• Minuscule chance of occurrence

High-priority risks should be the top priority for risk management. That said, if a less likely risk has the potential to cause significant financial damage, allocate your risk reduction efforts accordingly. In other words, when evaluating the level of risk for your business, consider the severity of potential consequences as well.

2. Get insurance coverage

Evaluate your business liabilities and legal requirements to determine the necessary insurance coverage. This may include property and casualty insurance, disability insurance, professional insurance, and cybersecurity insurance. Proper insurance helps transfer risks to insurance companies at a reasonable cost compared to potential uncovered risks.

3. Diversify your assets

Avoid putting all your eggs in one basket by diversifying your products, services, customer base, and even geographic locations, if applicable. This way, if one area of your business faces difficulties, others can fill in the gap.

4. Implement a quality assurance program

Build a good reputation for your business by prioritizing customer service and maintaining high product and service quality. Regularly test and analyze your offerings to make necessary improvements. Evaluate your testing methods to ensure they are effective.

5. Manage high-risk customers

Consider implementing a policy that mandates upfront payments from customers with poor credit. You can prevent potential issues by establishing a process to identify these customers beforehand.

6. Practice controlled growth

Assure proper employee training and focus on quality over quantity when setting goals for your team. Avoid pressuring employees to take unnecessary risks to achieve sales targets. Also, be cautious with rapid innovation; while it’s essential for success, overly fast innovation may lead to unsuccessful products or services.

The ROAR Platform Helps Businesses Understand and Manage Business Risk

Taking risks is essential for business growth, but it doesn’t mean you should accept risks beyond what you find acceptable.

The RiskOptics ROAR Platform is an all-in-one solution for facilitating IT and cyber risk mitigation, assuring compliance, and prioritizing tasks for your organization. It gives you a unified, up-to-date view of all the risks and compliance issues related to your business objectives, helping you understand the impact of these risks on your organization and make calculated risks to protect your systems, data, and overall organization.

Schedule a demo to learn how ROAR can help determine your business’s risk appetite.