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Risk management: Why it’s important in finance

14/06/2023 minute read Nadine Sutton

The process of recognising, valuing, and controlling hazards in a business setting is known as risk management. Everyone involved in finance-specific roles will need to engage in risk management at some point due to financial risks, regulatory burdens, or other exposures.

It is necessary for risk managers to evaluate and analyse the likelihood of losses. They can then use a suitable decision-making process to either accept, mitigate, or transfer the risk.

Types of risk a business may face

It is important for businesses to understand the kind of risks they might be exposed to, as even the ambiguous ones can be extremely consequential. Here are four examples managers and employees should be familiar with:

Operational risk

This is where there is a chance of financial loss due to mistakes or unanticipated circumstances. Manufacturers, for example, will lose money if the assembly line malfunctions and they’re unable to make goods. They must have backups for their assembly line or emergency finished products as part of a contingency plan to reduce operational risk.

Credit risk

This is the risk of not being paid by customers or lenders, such as when you allow a customer to pay in instalments, but they miss their payment. You might put some kind of legal agreement in place or ask for more money up front to lower your credit risk.

Market risk

This is the risk where your business may be impacted by market changes. For instance, If you sell luxurious/non-essential items, customers may not be so inclined to make these types of purchase during a recession. Diversify your products and clientele to reduce market risk. You may need to rethink your inventory management too.

Legal risk

This is the chance of being held accountable or facing legal action. One possible example is being penalised for operating in a non-compliant manner that breaches financial regulations. You should minimise your liability in this regard to reduce your exposure to legal danger. Cloud technology has proven to be an effective way of improving compliance.

How finance teams factor into risk management

Finance teams play a vital role in effectively managing risks within an organisation. They make valuable contributions by providing essential data and performing specific tasks to identify, assess, and mitigate risks. Here's a better way to describe how finance teams factor into risk management and their specific contributions:

1. Risk identification and assessment

Working closely with other departments, finance teams utilise the available data to identify and evaluate various risks. They scrutinise financial statements, market indicators, and other essential factors to pinpoint potential risks that could impact the organisation's financial stability. These risks may encompass liquidity, credit, market, operational, and regulatory aspects.

2. Risk modelling and scenario analysis

By employing data analytics tools and statistical models, finance teams construct risk models and conduct scenario analysis. Through stress tests and sensitivity assessments, they gauge the potential impact of different risk events on the organisation's financial health. This process quantifies risks, facilitates an understanding of possible outcomes, and aids in developing contingency plans.

3. Compliance and regulatory requirements

It is a critical role for finance leaders to ensure compliance with risk-related regulations. They monitor regulatory changes and implement necessary controls to mitigate compliance risks. Collaborating with legal and compliance departments, financial management systems can ensure that risk management practices align with legal obligations and regulatory requirements.

4. Internal controls and auditing

The team can establish and maintain internal controls to protect the organisation against risks. They design and implement control procedures that mitigate identified risks and monitor their effectiveness. Additionally, finance teams work with internal and external auditors during risk audits to evaluate the sufficiency and effectiveness of risk management processes.

5. Risk mitigation and monitoring

Finance teams actively contribute to the development of risk mitigation strategies. They collaborate with other departments to implement risk controls such as insurance policies, hedging strategies, diversification of investments, and contingency plans. Moreover, finance teams continuously monitor risk indicators and key performance indicators (KPIs) to detect emerging risks and take prompt action to mitigate them.

In summary, the finance department makes significant contributions to risk management by providing accurate and timely financial reporting, conducting thorough risk analysis, effectively communicating risks, establishing robust internal controls, and actively participating in ongoing risk monitoring.

Leveraging their expertise in data analysis and financial insights, they support decision-makers in making well-informed choices that safeguard the organisation's financial stability, resilience, and future prospects.

The right tools for risk management

There are many technologies that companies can use for managing financial risk. Here are five tools that can support organisational risk management:

Enterprise risk management (ERM) software

Enterprise risk management (ERM) is a holistic approach to identifying, assessing, and mitigating risks. ERMs, also known as risk management information systems, help finance teams to identify and analyse a wide range of threats. A good ERM system provides visibility into areas where undesirable risk could originate so that preventative measures can be taken.

ERM platforms may possess advanced artificial intelligence capabilities, such as data analytics, risk aggregation automation, risk assessment and simulation, natural language processing, and risk reporting.

While ERM tools are generally regarded as a necessity for many organisations, they are often complemented by more specialised software for managing specific areas. Robotics Process Automation (RPA) is one such AI capability that these systems provide to help with managing labour-intensive and repetitive tasks.

Governance, risk, and compliance (GRC)

GRC (which stands for governance, risk management, and compliance) can often be a complicated procedure. It is usually controlled by specialised software that combines several solutions into a single overarching framework. This can aid businesses in risk identification and assessment, resource sharing among team members, and the prevention of internal fraud.

Organisations may implement their GRC strategies more successfully with the aid of a comprehensive approach. This entails employing a common framework (rather than disparately housed data silos) and enabling financial risk managers (FRMs) to approach risk identification and assessment with more knowledge.

GRC technology adoption can take some time, but it can also have a big positive impact on efficiency.

Automated credit scoring technology

Credit-granting finance departments can gain from automated credit scoring technology. Automated credit scoring technology can assist FRMs in reducing the risk of payback default and maximising the economic performance of their organisations. Use cases for this technology include credit card issuance, personal loans, microloans, and consumer credit initiatives like buy-now-pay-later.

Credit scoring automation can examine ongoing customer history updates and draw insights about applicants for future more precise, informed decision-making using machine learning in the form of customer behaviour analytics.

Cybersecurity

Every organisation's approach to managing technology risk must include cybersecurity, thus FRMs must become more knowledgeable about cybersecurity tools and procedures.

There are many new opportunities for organisations due to digitisation and changing market developments. But because hackers and fraudsters are always developing new, sophisticated ways to conduct data breaches, commit financial fraud, and harm businesses with cyberattacks, it has also created a completely new profile of risk.

To develop strategic defence mechanisms against the danger of malware, cybercrime, and more broadly, to examine all kinds of cyber vulnerabilities, the leading cybersecurity solutions frequently include cutting-edge AI and machine learning capabilities.

Cloud computing

The transition from on-premise software infrastructure to scalable Cloud computing is accelerating. Cloud providers have addressed corporate concerns over fraud risks, such as data breaches and security threats. FRMs increasingly recognise that continuing with on-premise infrastructure may open their organisation up to more risk.

How OneAdvanced Financials can help you improve your risk management

Cloud-based accounting software from OneAdvanced provides ongoing maintenance and security updates, scales with your organisation’s needs, and evolves with everchanging tech advancements. By adopting Cloud computing as a prominent tool, businesses can shift away from the perils of outdated systems and have greater control over their financial outcomes.