Methodically approaching risks using a risk matrix can help organizations mitigate potential losses. Here's how your board should approach them.
Companies and organizations of all types face internal and external risks from nearly every angle in today’s volatile business environment. From the impacts of the ongoing COVID-19 pandemic to cybersecurity, compliance, competitive, reputational, and financial risks — it is easy for board directors and other organizational leaders to become overwhelmed at the thought of trying to navigate them all.
Taking a methodical approach to identifying, assessing, and planning for a multitude of risks using a risk assessment matrix or risk evaluation matrix can help organizations avoid or mitigate potential losses down the road. In this blog, we will define what a risk assessment matrix is, why it is important, how to develop a risk matrix, and how to determine the likelihood of a risk occurring.
What is a risk assessment matrix?
Risks are inevitable and ever-present in any line of business. Yet risks inherently involve many unknowns in terms of whether, when, where, or how they will hit.
A risk assessment matrix is a tool that helps organizations tackle those unknowns and formally analyze risks. It is used to map risks by gauging the likelihood they will occur and estimating the impacts. A risk matrix helps leaders manage uncertainty by prioritizing and preparing for forthcoming challenges to avoid or lessen their potential damage.
There are multiple names for a risk assessment matrix, including probability matrix, impact matrix, severity risk matrix, risk assessment score matrix, risk evaluation matrix, or simply risk matrix, just to name a few. While risk assessment matrix templates vary, they generally take the form of an Excel-style chart that visually graphs the probability of specific risks occurring compared to the potential impacts of those risks.
Color coding often is used to depict the severity of the risk, with red indicating high-probability and high-impact risks, for example, and orange, yellow, and green used for successively lower probability and lower-impact risks. This allows leaders to identify at a glance which risks are categorized as high, moderate, or low so they can develop appropriate mitigation strategies.
The risk assessment matrix and resulting strategies then can be integrated into an organization’s comprehensive strategy for managing governance, risk, and compliance (GRC) to help ensure coordination across various departments organization-wide.
Why is a risk assessment matrix important?
Events in recent years have clearly demonstrated the importance of strategic risk assessment and contingency planning. Organizations have had to confront multiple challenges, such as the ripple effects of COVID-19, volatile capital markets, inflation, nationwide labor shortages, and mounting cybersecurity threats. The pressure on boards and executive leaders to accurately anticipate and effectively manage an increasingly complex array of risks has never been higher.
A risk assessment matrix provides a vital tool for staying on top of risks as they emerge, or averting them before they arise. Four key reasons to use a risk matrix are:
1. Gain clarity on the current risk landscape
A risk assessment matrix essentially provides a dashboard to help leaders visualize and quickly gauge the scope and severity of potential threats. It distills complex information in an easy-to-understand format. Leaders then can quickly determine — based on likelihood and severity — which risks should be given the highest priority for further analysis.
2. Prioritize contingency planning
Once those high-priority risks are identified, leaders can work with others (such as audit, finance, and compliance professionals) to conduct a more robust risk analysis to thoroughly assess their possible effects and build contingency plans to address any vulnerabilities within the organization. The risk assessment matrix lays the groundwork to help leaders prioritize and establish a targeted risk management plan to neutralize or lessen losses and other possible repercussions.
3. Identify trends and pinpoint recurring risks
Presenting a spectrum of risks in chart form has an additional benefit in that a risk assessment matrix allows organizations to track risks from year to year. It provides clear documentation of the most pressing risks at any given point, thereby creating a record of risks over time. Organizational leaders can use a risk matrix to monitor risks as they evolve, identify trends or patterns, and recognize recurring risks that may warrant long-term mitigation efforts. This helps leaders view risks in a broader context and provides further clarity for the development of effective risk management strategies.
4. Stay on top of evolving risks
By integrating the development of a risk assessment matrix into routine GRC management processes, boards and other organizational leaders have an established method for proactive risk planning. It serves as a trigger for them to look for early warning signs, reevaluate current risk trajectories, and think ahead to future risks — thus enabling them to keep pace with an ever-evolving risk landscape.
How does a risk assessment matrix work?
The goal of developing a risk assessment matrix is to synthesize complex information. It boils complicated risk dynamics down into a simple chart. One axis looks at the potential effects of given risks along a scale of minimal to severe, while the other axis considers the probability of those risks ever occurring from a range of highly unlikely to very likely.
As previously mentioned, color coding using red, orange, yellow, and green typically is used to indicate the interplay of these two key measures. For example, a risk event gauged to be both highly likely to occur and to have the potential for severe losses would be coded in red, while a far less probable risk event projected to have minimal effects on the organization would be coded in green. Risk events in between these two extremes would be coded as orange or yellow, accordingly.
Leaders should tailor the color coding to suit the unique risk tolerance and risk appetite of their specific organization, business, industry, or market. Some leaders, for instance, would also use red to indicate risks that, while not highly probable, would be so detrimental to the organization that they become elevated in priority for risk management planning.
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How to make a risk assessment matrix
Creating a risk matrix involves a step-by-step process. You must identify and analyze all risks relative to a specific project or endeavor. The applications are endless — an aspiring entrepreneur may develop a risk assessment matrix to gauge risks associated with opening a new small business, a nonprofit hospital board may request one to analyze a service line expansion, or a private corporation may generate a risk matrix to weigh the risks of pursuing an initial public offering (IPO). Five key steps for how to make a risk matrix are:
1. Develop a comprehensive list of risks
To analyze risks, you need to identify what those risks are. This first step involves equal parts brainstorming, researching past and current risk trends, and projecting possible future threats. This shouldn’t be a siloed or small-team effort. It requires gathering insights from across the organization or even tapping external experts to help identify a complete range of risks.
Risks of all kinds and from all angles should be considered, including internal, external, operational, financial, reputational, etc. This step becomes easier in subsequent risk assessments if the board does it well, because leaders can update and build upon any previous matrix in identifying risks.
2. Assess the probability of each risk
The next step involves ranking the various risks you have identified by how likely they are to occur. Each risk should be categorized as very likely, likely, possible, unlikely, or very unlikely, or by some other comparable scale. This serves as the first stage of the risk analysis as the first measure of the two axes in the risk assessment matrix.
3. Evaluate the impacts
Once probability is determined, the third step is to weigh the potential effects of the different risks by severity. This measure may include categories such as:
- Intolerable for risks that could cause permanent ruin to an organization
- Unacceptable for risks that could cause significant disruptions
- Tolerable for risks that would have moderate repercussions
- Acceptable for those risks that would have minimal effects
4. Chart your risks
The final step is to take all the information garnered from the previous steps to graph the risk assessment matrix. Each risk is placed on the matrix by its ranking of probability relative to severity of impact. Once all risks are mapped on the chart, the matrix can be color coded according to criteria determined by the specific organization, as discussed in the previous section.
5. Routinely reassess risks
Once you have created an initial risk assessment matrix, board directors and executive leaders can proceed with prioritizing the allocation of resources for your risk mitigation strategies. The risk matrix itself, however, should not be a one-time, static document. It should be periodically reevaluated and revised — ideally multiple times a year — as risks change and as new risks arise. A risk matrix should continually evolve with the shifting risk landscape.
How to Determine the Likelihood of a Risk Occurring
Determining the probability of a risk occurring is a crucial calculation in the construction of a risk assessment matrix. A miscalculation of this metric can throw off the validity of the entire exercise and ultimately cost organizations a great deal in lost time and resources.
While there are no crystal balls, there are established mathematical methods for estimating probability with some level of accuracy. It should not be back-of-the-napkin arithmetic, but a formal calculation. Some organizations may opt to use software, or an actuary or other statistics professional to help them calculate the probability of various risks occurring.
Using the sample categories previously mentioned, an organization may classify probabilities as:
- Very likely: 90% or more likely to occur
- Likely: 60%-89% likely to occur
- Possible: 40%-59% likely to occur
- Unlikely: 10%-39% likely to occur
- Very unlikely: Less than 10% likely
The exact classifications and their respective parameters will vary from one organization to the next.
Assess your risks effectively with OnBoard
Risks are dynamic by nature, but so are businesses and organizations. In general, all organizations must be willing to take on some level of risk to succeed. Developing a risk assessment matrix provides a valuable tool for assessing a broad range of risks, and charting a path forward that effectively abolishes or minimizes the effects of those risks. It helps boards of directors and executive leadership teams establish clear priorities, better allocate risk management resources, and avoid unnecessary losses.
OnBoard’s comprehensive board management solution provides a secure, easy-to-use platform to help boards manage all of their GRC needs. Our technology helps organizations uncover insights and simplify board management processes so they can anticipate challenges before they arise.
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