Risk Rating

What is a Risk Rating?

Risk Rating is assessing the risks involved in the daily activities of a business and classifying them (low, medium, high risk) on the basis of the impact on the business. It enables a business to look for control measures that would help in curing or mitigating the impact of the risk and in some cases negating the risk altogether.

In situations where the risk cannot be mitigated or negated the business has to accept that the risk is open and there are no control functions to curb the impact. It depends on the likelihood of the risk event occurring and the severity of the impact on the business and its employees.

Categories of Risk Rating

Risk is rated on the impact on the business which can be economic or reputational and its likelihood of occurring in the near future. This is the common pattern of risk across businesses.

Impact of Risk Rating

  • Low: A low rated event is one with little / no impact on the business activities and the reputation of the firm.
  • Low/Medium: Risk events that can impact on a small scale are rate as low/medium risk.
  • Medium: An event that would result in risks that can cause an impact but not a serious one is rated as medium.
  • Medium/High: Severe events that can cause a loss of business but the effects are below a risk that is rated as high.
  • High: A major event that can cause reputational and economic damage that will result in huge business and client base losses.

Likelihood Rating

This rates the risk on the basis of its recurrence which can change depending on the type of the business that is being considered. For example, for a fast-food company, a frequent likelihood rating will be something that can happen every day whereas for an investment bankInvestment BankInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more it would be something that happens in a month or so.

  1. Frequent
  2. Likely
  3. Possible
  4. Unlikely
  5. Rare
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Source: Risk Rating (wallstreetmojo.com)

Risk Rating Example

Below is an example of the Risk rating on the basis of its impact on the business. The financial impact rating on the business may vary depending upon the business and the sector in which it operates. Business with lower income can have a $500k as a high-risk event where for a higher income business will rate it as a low-risk event. The rating purely depends on the sector that the business is operating in.

risk rating example

Likelihood Rating

risk rating example 1

Advantages

  • Studying the risk involved in a business activity helps in taking appropriate measures to either curb the effects of the risk or completely eliminate the risk.
  • Event risk helps in a better understanding of the risk and working towards enhancing the current procedures.

Disadvantages

  • This is an assumption of the impact it can have on the business which if not done diligently can cause economic and reputational damage to the organization which may eventually result in loss of business.
  • This is a complex process and requires a high level of experience and thoughtfulness to foresee potential risks that can impact the smooth functioning of the business.

Conclusion

  • Risk Rating refers to the classification of risks and their impacts on the business in terms of reputational or economic damage to an organization or a sector.
  • Organizations should consider in conducting at least a yearly review of the risk rating due to the fast-paced business environment.
  • It enables a business to be well informed about all the potential risks that can cause an impact to the business along with the likelihood of the event’s occurrence.

This has been a guide to What is a Risk Rating and its Definition. Here we discuss the categories of risk rating along with the example, advantages, and disadvantages. You can learn more about accounting from the following articles –