How to Calculate Risk Probability
When you run a business, a crucial job is predicting and managing risk. Any organization undertaking complex business projects will face a certain amount of risk. You can't necessarily tackle every single risk a company may face. Instead, as a business manager or owner, you will need to assess the most probable risks your company will face and also determine the ones that could have the greatest impact on your company.
To assess the impact and probability of each potential risk your company may face, try creating this simple tool.
- Draw a square.
- Label the left side of the square "Probability of Occurrence."
- Label the bottom side of the square "Impact of Risk."
Each corner of the box now has a set of characteristics. Brainstorm the risks faced by your company, then list them where they belong on this chart. To make the chart more exact, write numbers 1 through 10 along the left side and along the bottom side of the square.
- Bottom-left corner: In this spot, write down risks with low probability and low impact.
- Top-left corner: This spot denotes any risks that have a high probability of occurring but low impact.
- Bottom-right corner: Any risk in this corner would have a high impact, but there is a low probability that it will occur.
- Top-right corner: Any risk you put in this corner has both a high probability and high impact.
This chart is a useful tool because it allows you to fully consider potential risks, then assess which of these require your attention. Any risks you write down in the top-right corner of your chart need most of your planning and vigilance. Risks in the bottom-left corner can be ignored. Risks in the other two quadrants require some planning and assessment, but not nearly as much as the high-impact, high-probability risks.
Many companies take a rear-view mirror approach to risk. They look at what has gone wrong, then put policies in place so that it doesn't happen again. One example on a large scale is the financial crisis of 2009. Banks and other companies established new rules with the hope of avoiding another financial collapse. But are those rules working in today's business climate? That is still up for debate, but this example reveals that dealing with risk after a debacle is complicated at best.
CEB, a Washington-based firm that researches best-business practices found that while strategic risks hit 86 percent of companies the hardest, most of their money and research goes into legal, financial and compliance risks.
The same study also revealed that executives involved in company strategy feel their company's decision-making process is much too slow. This decision-drag makes managing strategic risk more difficult. To that end, many of the companies studied plans to reorganize their priorities in terms of risk management.
We learn from history, and while it may not be a perfect template for what is to come, it is important to look at past problems and determine how they may have been avoided.
For example, many mortgage lenders made mistakes – some even committed crimes – during the financial crisis that led to the Great Recession. Now, many of these lenders have stricter practices in place to lessen the risk of history repeating itself.
However, these restrictions can create problems of their own. People may not be able to get a mortgage due to their credit scores alone. In the past, approvals were based on a review of the entire work and credit history. Sometimes, overcorrecting does not solve the problem of risk. Striking the right balance between risk and reward is a difficult sweet spot to find.