Risk Categories

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Risk Categories Definition

Risk categories can be defined as the classification of risks as per the business activities of the organization and provides a structured overview of the underlying and potential risks faced by them. Most commonly used risk classifications include strategic, financial, operational, people, regulatory and finance.

Risk Categories

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Risk Categories (wallstreetmojo.com)

Such risk elements pose a hindrance to the smooth and structured operation of the company by forcing it to slow down the normal work process and restrict it from achieving its full potential. As already mentioned above there are various types of such risk but it is always possible to mitigate or minimize their negative effects in the business through strategic planning and proper implementation of the same.

Key Takeaways

  • Risk categories are classifications or groupings of risks based on common characteristics, sources, or impacts. They help organize and understand different risks within an organization or project.
  • Common risk categories include strategic risks (related to achieving organizational goals), operational risks (associated with day-to-day operations), financial risks (related to financial performance and stability), compliance risks (related to adherence to laws and regulations), and reputational risks (associated to the organization’s image and perception).
  • Categorizing risks allows for a systematic and comprehensive approach to risk management, including identifying, assessing, and mitigating risks within each category.

Risk Categories Explained

Risk categories refer to the various types of risk that any business venture of organization may face during its daily operation. Such risks may be natural or man-made but are an integral part of the business world. They are an accepted segment of any enterprise which has been dealt with through proper planning and devising useful but achievable strategies.

It is very common for a business to face predictable or unpredictable situations that hinder its smooth working. These project risk categories are not limited to any particular stage or level of an organization, but may arise quite suddenly even through there is through planning and supervision. But it is generally seen that any kind of risk affect the companies which are at their initial or growing stage more as compared to the established ones, because the latter has already had a prominent place for itself in the market through accumulation and access to useful resources, financial strength, infrastructural and operational efficiency along with proper coordination and cooperation.

Such business risk categories affect a business at any level internally or externally. The management, stakeholders, or even the general public. Ultimately they result in rise in cost, fall in sales, revenue and profits, loss of reputation in the market, hampering the customer base. Clients lose trust and start switching to competitors making the survival of the business difficult in the market. It is important to identify and understand the repercussions of such risks in order to handle them on time.

Why Do We Use Risk Categories?

Every idea or concept has both pros and cons. Along with their negative effects, it is also necessary to identify the usefulness of this concept of business risk categories. Let us study the same.

  • Risk categories help identify risks and enable them to become robust and practical at the same time.
  • It ensures that the users can track the origin of the underlying and potential risks faced by an organization.
  • These categories help determine the efficiency of the control systems implemented in all the departments of an organization.
  • It ensures that risk identification is made comprehensively, covering all the probable aspects of the underlying and upcoming risk conditions.
  • With these categories, users can determine the areas that are highly prone to risks, and it even allows for the identification of standard and probable causes.
  • With risk categories, users can even develop appropriate risk dealing mechanisms.

How To Identify?

An organization must scrutinize its process assets to find out if the same has a defined set of risk categories or not. The users can make use of techniques like the Delphi techniqueDelphi TechniqueThe Delphi method can be termed a forecasting process framework wherein the main objective is to arrive at a group consensus.read more, SWOT analysisSWOT AnalysisSWOT Analysis is an analytical tool to identify and evaluate an entity’s strengths, weaknesses, opportunities, and threats.read more, documentation reviews, information gathering techniques, brainstorming, root cause analysisRoot Cause AnalysisRoot cause analysis is a problem-solving technique in which the source of a problem is identified, thereby finding the best possible solutions to it. It is a permanent fix to an issue since it establishes a cause-effect relationship for every adverse situation.read more, interviewing, assumption analysis, checklist analysis, risk register, outputs of risk identification, impact matrix, risk data quality assessment, simulation technique, etc.

We can explain the steps elaborately using the following points:

Monitoring – The management should keep a continuous monitoring system in place within each department of the organization which can be either manual or electronic form. All key components of an organization, like the human capital, finance, software system, client feedback, supply chain, etc are common areas in which the company depends a lot. It is crucial that the management has a good monitoring system in place which will keep continuous check on all areas, particularly the above through realistic contingency plans to avoid project risk categories.

Scenario Assessment – It is important that managers and risk analysts try to play out different scenarios within the company and assess the result of the same. In other words, some simulated situations can be designed which will help management to understand what exactly may happen and devaluate the threat level in case such risks take place in reality. This will help in strengthening key areas of the business.

Analyse the past and current activities – Analysts should look at the past scenarios and compare them with the present. They should review the projects handled in the past and products already launched in the market to evaluation how they have performed. Critical analysis using SWOT analysis techniques, resources used, how much profitability has increased, etc, will provide good insight into the possible risks in future. Some vulnerable areas may also come into light through interaction with people who handled them, like sales team, vendor, distributors and so on.

Review of assumptions– Various planning and production or project related ideas are often used with some assumptions. It is important to understand the feasibility of such assumptions because very often risk categories in project management pose to be a threat to the smooth working process of an enterprise. They may have huge repercussions. Thus, the management should identify potential risk from them and their possible future consequence for the business.

Identify the root cause – The company should identify the root cause of any issue so that future problems can be minimized. Proper investigation, such as why a software system failed, why the goods could not be delivered on time, why there was an equipment malfunction, etc.

Therefore, it is necessary to perform the above functions so that risks can be identified, and proper steps can be taken on time to avoid any major loss, delay or failure due to risk categories in project management.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Types

The following are the categories of risk –

#1 – Operational Risk

Operational risksOperational RisksOperational risk is the business uncertainty a company comes across in the industry while executing its everyday business operations. Such risks arise due to internal system breakdown, technical issues, external factors, managerial problems, human errors or information gap. read more can be defined as the risks of loss arising from improper implementation of processes, external issues (weather problems, government regulations, political and environmental pressures, and so on), etc. Operational risks can be better understood as a type of risk due to inefficiencies in business operations carried out by an organization. Examples of operational risks are insufficient resources, failure in resolving conflicts, etc.

#2 – Budget Risk

Budget risk can be defined as a risk that arises from an improper estimation of a budget allocated to a particular project or process. Budget risk is also regarded as cost risk, and the implications of such a risk are delay in the completion of a specific project, premature handover of the project, failure to deliver the quality project or compromise in the quality of the project in comparison to what was committed to the client, etc.

#3 – Schedule Risk

When the release or completion of the project is not assessed and addressed correctly, the schedule risk takes place. Such a risk can impact a project and might even be the reason behind the failure of the same and, thus, can result in losses for the company.

#4 – Technical Environment Risk

Technical environment risk can be regarded as the risk concerning the environment in which both the customers and the clients operate. This risk can take place due to the testing environment, regular fluctuations in production, etc.

#5 – Business Risk

Business risksBusiness RisksBusiness risk is associated with running a business. The risk can be higher or lower from time to time. But it will be there as long as you run a business or want to operate and expand.read more can occur due to the unavailability of a purchase order, contracts in the initial stage of a particular project, delay in the attainment of inputs from clients and customers, etc.

#6 – Programmatic Risk

These are the risks that are not within the control of a program or outside the purview of the operational limits. Changes in product strategy or government regulations are examples of programmatic risks.

#7 – Information Security Risk

Information security risks are concerned with the breach of the confidentiality of a company’s or clients’ sensitive data. The violation of such data can be a huge risk for an organization, and it might not just cause financial losses but also result in loss of goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read more.

#8 – Technology Risk

Technology risks occur due to sudden or complete change concerning technology or even the installation of new technology.

#9 – Supplier Risk

Supplier risks take place in a scenario where there is third-party supplier interference in the development of a particular project owing to his association in the same.

#10 – Resource Risk

Resource risk occurs due to improper management of a company’s resources such as its staff, budget, etc.

#11 – Infrastructure Risk

Infrastructure risk takes place as a result of inefficient planning concerning infrastructure or resources, and that is why it is always essential to have appropriate planning of infrastructure so that the project does not get impacted.

#12 – Technical and Architectural Risk

Technical and architectural risk are such types of risk that fail the overall functioning and performance of an organization. These risks arise out of the failure of software and hardware tools and equipment that are taken into use in a particular project.

#13 – Quality and Process Risk

Quality and process risk occurs due to improper application of customizing a process and hiring of staff to the process that is not well trained and as a result of which the outcome of a process gets compromised.

#14 – Project Planning

Project planning risks are such risks that arise out of lack of proper planning concerning a project. This lack of project planning can cost the project to sink and fail to meet the expectations of the clients as well.

#15 – Project Organization

Project organization is another risk associated with the improper organization of a particular project. This lack of project organizing can cost the project to sink and fail to meet the expectations of the clients as well.

Example

Let us understand the concept with the help of a suitable example as given below:

Let us assume that ABC Ltd is a wholeseller of medicines and has a warehouse in which it stores various types of medicines for supply. It is obvious that such an area will require proper infrastructure like cold storage, dry and clean place where the medinices can be kept for quite a long time. But the management has not paid attention to its maintenance for quite some time, resulting in leakage, loss of power facility and accumulation of dirt and dust. This resulted in huge quantity of medicines getting spoilt. This is an example of man-made risk.

If we take the same example and assume that there is a sudden cyclone in the area, leading to heavy rain, but the company has constructed the storage facility underground with good power backup and continuous monitoring of stocks through automatic scan and entry being made in the software system, which also triggers any unusual activity within the storage area, it becomes a perfect example of good risk control measures.

Thus, from the above example we clearly understand the risk related to enterprise risk categories can be predictable or unpredictable, but they can be managed and controlled to a huge extent through proper measures.

Frequently Asked Questions (FAQs)

Why are risk categories important in risk management?

Risk categories are essential in risk management as they help organize and understand the wide range of risks an organization or project may face. By categorizing risks, it becomes easier to identify, assess, and prioritize risks, develop appropriate risk mitigation strategies, and ensure that all critical risk areas are adequately addressed.

How should risk categories be determined?

Determining risk categories involves considering the specific characteristics, sources, and impacts of risks within the organization or project. It requires a thorough analysis of the business or project activities, stakeholder concerns, industry best practices, regulatory requirements, and historical risk data. Involving relevant stakeholders and subject matter experts can help identify and define appropriate risk categories.

Can risk categories belong to multiple categories?

Yes, risks can belong to multiple categories. Some wagers may have overlapping characteristics or impacts that make them relevant to various types. It is essential to consider the complexity and interdependencies of risks while categorizing them and ensure they are captured within the appropriate categories.

Recommended Articles

This has been a guide to Risk Categories & its definition. We explain it with example, types, how to identify & why we use them. You can learn more about from the following articles –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *