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Use these important 3 tips to improve your risk assessments!

by , 02 March 2015
Whether it is about income, inventory, clients or other factors, as an employer, you take risks in your business daily.

Many of the new risks you take come with your most feared risk: The closure of your own business.


How do you take risks? Consciously or unconsciously?

Well, according to Walt Smith, Sr. Architect at Carmax, you should take risks based on a risk assessment that you model.

The best way is to follow a business plan that includes this sort of analytic risk assessment in the form of a SWOT (Strengths, Weaknesses, Opportunities and Threats) matrix.

This is because the patterns we make are usually based on feelings, past experiences or other factors we often don't even realise. These aspects can sometimes make us engage in a "faulty risk assessment", as Smith explains. By that he means that you over or under value the risks associated with a future decision based on irrational weighting of both risks and consequences.

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And that's a problem. Because a faulty risk assessment can make you spend money where it is not needed, or underestimate a risk that could be catastrophic to your company!

Here are there tips for improving risk assessment:

1) Risk / reward models usually follow a curve.

Like Smith puts it, "eighty percent of the reward can usually be had for twenty percent of the risk." In other words, the risk increases as one tries to optimise an outcome. More energy leads to better results but also increases the risks.

"These changes will likely destabilise workers, will probably increase defects, and will affect all sorts of other departments in the company from accounting to HR. So risk increases all around us as we make the changes," Smith explains.

How to manage risks better? You have to be incremental in change and model change along a curve of risk and reward so that you get most of the reward without taking on inordinate amounts of risk.

2) Risk assessment must evaluate the consequences.

This is a step you have to take because two risks may be equal, but they may have totally different consequences. For instance, one risk with two choices of investment may lead to different consequences. Solutions given by Smith? You have to use a surface: "a multi-dimensional mathematical model, and in this case, one that includes not only the risks involved in a decision, but also the consequences."

So calculate the relative likelihood of a bad outcome, and the relative consequences of such an outcome, and place the resulting point on the surface. The same method applies for all alternatives. And when you finish, the point that is lower and to the left in the matrix is generally the least risky alternative.

3) Risk should not be discounted over time.

You may have the habit of thinking that if something doesn't happen in a while, it is unlikely to happen. This is how you take risks that you shouldn't be taking (like not wearing your seatbelt while driving).

How do you translate this in the business world? It's called irrational faith in the quality of people, processes and technologies. Companies don't improve their security system over time, for instance, because they haven't had a security break (yet).

But do remember this tip from Smith: A risk assessment is one of the most difficult tasks in business and in life itself so we should apply a more scientific approach instead of relying on our emotions.

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