Operational risk is a term that is used in business to describe the potential for losses arising from inadequate or failed internal processes, people, and systems. Every business faces some level of operational risk, and it is important to be aware of these risks and take steps to mitigate them. In this guide, we will discuss what operational risk is, how to identify it, and steps you can take to reduce the chances of a loss occurring.
What is operational risk?
Operational risk is one of the most common types of risks businesses face. It refers to any potential losses that could arise from an internal procedure, such as:
- A system failure,
- Human error, or
- An unexpected event (such as a fire).
Operational risk can lead to partial or complete loss of revenue, damage to company reputation, and even legal action. It is important for businesses to understand the types of risks they face and take steps to mitigate them.
How to identify operational risk
There are a number of ways you can identify operational risk in your business. One way is to perform a hazard identification assessment. This involves looking at your business processes and identifying any potential risks. You can then take steps to mitigate these risks.
Another way to identify operational risk is through a review of insurance policies. Make sure you are aware of the types of losses that are covered by your insurance policies, and what events would not be covered. This can help you to understand the level of operational risk in your business.
How to manage and mitigate operational risk
Operational risks can be managed through a number of key steps:
- Identifying the types of risks that could occur (hazard identification)
- Taking steps to prevent these events from occurring, or at least reducing the likelihood. For example, by implementing risk management procedures,
- Having a plan in place for how to respond if an incident does occur, and
- Regularly reviewing and updating your risk management plan.
By taking these steps, you can reduce the likelihood of operational losses occurring in your business.
Is operational risk the same as financial risk?
Operational risk is not the same as financial risk. Financial risks refer to any potential losses that could arise from a business’s finances, such as:
- Bankruptcy or other insolvency events,
- An inability to meet contractual obligations due to insufficient funds, and/or
- Changes in the value of investments.
Financial risks are typically managed through risk management procedures related to finance, such as cash flow forecasting and credit risk assessment. While operational risk and financial risk can both lead to losses for a business, they are two separate types of risk.
We’ve seen that operational risk should be considered in any business and it is important to identify potential risks before they cause damage. In order to mitigate these risks, you need to have a plan in place for how you will respond when something goes wrong.
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