The focal issue in risk management is on minimizing the adverse effects of risk, which is the attendant losses arising from risks. These associated losses are capable of causing economic loss that is loss in the desired profit motive venture and non-economic loss that loss in other values nor necessarily on profit-oriented enterprise, is an example moral decadence, social costs and private costs. Private costs are those costs necessarily incurred by the individual or firm engaging in a particular activity.
The private costs have direct effect on the individual or firm say loss of ones car to armed robbers, meeting the costs of inputs which will appear in the books of accounts of firm and loss of any financial interest on values or properties.
Social cost on the other hand refers to the cost borne by the public arising from the activity. Effects of oil spillage, loss of employment, industrial pollution and loss of amenities are example of social cost are;
1. Risk
identification
2. Risk
measurement and
3. Risk
treatment.
Risk identification implies the study of an entity exposed to risk,
and its working with a view to detecting all the risk elements thereto, three things are involved in
risk identification: being able to recognize that there is an exposure to risk
that is risk factor, diagnosing or pinpointing the perils that is the loss
producing agents and the possible outcomes. The combinations of the three
functions must be systematically pursed so as to produce a list showing
possible sources of loss, otherwise the risk elements thereto.
Thorough risk identification, an organized process of doing it must be evolved so as to be able to arrive at near complete loss-exposure list consisting of events which can lead to loss of material and human resources. There is no one catch-all technique for the risk identification. Each entity should develop its own techniques considering its numerous constraints say finance, expertise and knowledge and above all the nature of risk which itself is uncertain and dynamic, this implies that the risk identification must be an ongoing process for any entity.
In a business organization some helpful aid to identifying risk will include the study of the organizational charts flow charts, accounting records, contracts agreements, purchasing and sales conditions. A study of the buildings, fixture and fittings and the environment of the entity with a view of detecting Risk elements thereto, should be carried out too. Household affair, the helpful aid to risk identification will encompass the study of the individual medical history occupational hazards, family health history and societal attitudes.
Risk measurement: Is the second element or
process of risk measurement that is handling risk, it can be referred to as risk
evaluation because the aim is to gather information on the identified risk. The
information to be gathered related to:
·
The
frequency of the loss producing event
·
The
impact and severity of loss
·
The
maximum possible loss
The frequency of the loss producing event implies the number of time or how frequent the perils like fire on a house, a car, or a factory occurs within a given period, usually one year the perils in question may be theft pilfering storm power failure, car collision, drought, and earthquake.
The information on the frequency of loss
producing event are aimed at knowing how many times an event in question , the
say fire has occurred within a specific period of time.
The information on the impact and the severity of the loss is to know or determine the extent of damage caused by a given loss producing event. And most importantly, the financial losses suffered because of the occurrence of the presented in financial term say Naira or Dollars.
In many instances, events with high
frequency of occurrence produce lesser severity of loss than events with low
frequency of occurrence. A host of factors can influence the severity of loss.
Some of them include market price, extent of physical damage, accounting
method, business policy and government fiscal and monetary policies.
The information on the maximum possible loss implies knowing the maximum financial loss that will be suffered should a given peril occurs within a given period. It simplifies understanding to know that there are events that will produce catastrophic results. And there are some that will make a minute impact on the financial interest of the entity.
The aim of this information on maximum possible loss is
to know the maximum loss an event could create or the maximum loss possible.
This information will help in preparing the entity to combat the losses in
future should they occur. Therefore, different level of loss calls for
different level of treatment, at least in that graduating manner.
Risk evaluation can be carried out both in qualitative manner and in quantitative manner. The qualitative way uses no numerical or historical data in its risk measurement. It simply requires critical observation of activities so as to come up with likely loss-producing events.
For instance, a critical study of a flow chart
(that is schematic representation of the order of occurrence of
events/activities which constitute completion of some desired objectives) in a
shoe manufacturing company may indicate that the personnel cutting the leaders
are careless, hence the increasing number of wastes, further inquiries may
reveal that the staffs concerned have no job satisfaction hence the indirect
expression of displeasure on poor working condition and inadequate motivation.
Risk treatment: it
is the next logical step after risk evaluation in the risk management process.
After all problem definition comes before solution or strategy application
aimed at alleviating the perceived problem. The treatment for a particular
problem, in our case, the adverse effects of loss-producing events, will differ
in methods and techniques in relation to person managing the risk.
The application of
any methods or combination of technique is limited by the following factors:
1. The desired objectives of the entity’s risk
management policy.
2. The level of technology and culture of the
system, industry or household.
3. The type of risk pure or speculative;
fundamental or particular; dynamic or static.
4. The resources available to the entity say
human, financial and opportunities.
Though the limiting factors effects the risk treatment techniques to apply, in practice the application of common sense rule in needed. In the world of business, pure risk interweave with speculative risks such that each is contained in the other.
Thus, any change in a dynamic risk of an entity will
likely introduce a change into the static risk of the entity.