Determining Internal and External Business Risk

Did you know that the global risk management market is projected to reach $35.9 billion by 2032? This growth underscores a fundamental truth: uncertainty is an ever-present challenge in today’s fast-paced business environment. Economic shifts, technological advancements, regulatory changes, and operational disruptions are just a few examples of risks organizations must navigate daily.

But what if businesses could proactively identify these risks, minimize their impact, and even turn them into growth opportunities? The ability to anticipate risks is often the difference between thriving in a volatile market and struggling to keep up. 

By understanding the different types of risks—internal and external—businesses can better prepare for the unpredictable nature of today’s market.

In this article, we’ll explore the mechanics of business risk, break down the difference between internal and external risks, and highlight actionable strategies for mitigating them. 

Understanding Business Risk

Business risk refers to the potential threats or uncertainties that can hinder an organization’s ability to achieve its objectives. These risks can arise from both internal and external factors, impacting areas such as operations, financial performance, compliance, and reputation.

Understanding these risks is crucial for businesses to mitigate potential challenges and drive long-term success. Now, let’s take a deeper look at the difference between internal and external risks and how they influence risk management strategies.

Internal vs. External Risk

Risk management can seem overwhelming due to the vast array of factors contributing to the risks your business faces. A simplified approach is to categorize risks into internal and external types. Understanding the distinction between the two can help your business anticipate and address potential challenges more effectively.

Internal Risk

Internal risks originate within the organization. These are risks tied to the business’s operations, resources, and decision-making processes. Internal risks are typically within your control, meaning that effective management can reduce their likelihood or impact. 

Common sources of internal risks include:

• Business Processes: Inefficiencies, outdated procedures, or system breakdowns.
• Human Resources: Employee errors, misconduct, lack of training, or insufficient staffing.
• Technology: Cybersecurity threats, system failures, or inadequate IT infrastructure.
• Organizational Culture: Misalignment of values, poor communication, or low employee morale.
• Leadership and Management: Poor decision-making, lack of strategic direction, or leadership gaps. 

How to Prepare for Internal Risks?

To effectively manage internal risks, businesses need to adopt proactive measures that focus on improving processes, strengthening human resources, and optimizing systems. Here’s how to prepare: 

• Risk Identification and Assessment: Conduct regular audits of operations, employee performance, and technological infrastructure to identify areas of vulnerability. 
• Clear Policies and Procedures: Implement well-defined internal policies and procedures to reduce errors and enhance operational efficiency.
• Employee Training: Offer ongoing training to improve employee skills, minimize mistakes, and promote compliance with company standards.
• Cultural Alignment: Foster an organizational culture of open communication, shared values, and teamwork to reduce risks related to mismanagement or lack of coordination.
• Cybersecurity: Strengthen IT systems and cybersecurity measures to prevent data breaches and system failures.
• Leadership and Management: Promote strong leadership and sound decision-making practices to ensure your business stays on track. 

External Risks

External risks arise from factors outside the organization, such as economic shifts, regulatory changes, and natural disasters. These risks are generally less predictable and beyond the organization’s direct control. They can have high consequences, potentially disrupting operations, causing financial losses, or damaging the organization’s reputation. So, recognizing and mitigating their impact is essential for maintaining business resilience.

Common sources of external risks include:

• Economic: Fluctuations in the market, inflation, or economic recessions
• Political: Changes in government policies, regulations, or political instability
• Social: Shifts in consumer behavior, demographic trends, or societal values
• Technological: Rapid innovations, disruptive technologies, or cybersecurity threats
• Environmental: Natural disasters, climate change, or resource scarcity
• Legal: Changes in laws, regulations, or trade policies

How to Prepare for External Risks?

External risks are often unpredictable, but businesses can prepare by developing strategies to minimize their impact or adapt quickly when these risks arise. Here’s how to prepare for external risks:

1. Identify the Risk: What external threats could affect your business operations?
2. Assess the Impact: How might these risks influence your company’s performance? Consider both short-term and long-term effects.
3. Evaluate Likelihood: What is the probability of these risks materializing?
4. Understand the Consequences: What would be the severity of the consequences if these risks occurred? Gauging this will help define the necessary actions to mitigate or recover from the impact.

By recognizing these external factors, businesses can develop targeted response strategies to minimize risks and adapt when necessary.

Now that we have a clear understanding of internal vs. external risks, it’s time to explore the challenges that companies have to face to manage them.

Also Read: Web-Based Advanced Risk Assessment and Management Software Solutions

Challenges in Managing Internal and External Risks

Managing both internal and external risks presents unique difficulties, requiring businesses to balance proactive strategies with the ability to adapt to unforeseen circumstances. Let’s look at the challenges:

Challenges in Managing Internal Risks

1. Limited Control: Some internal risks, like employee behavior or system failures, can be difficult to predict and control despite efforts in management.
2. Resource Constraints: Allocating enough resources (time, money, personnel) to address internal risks may be challenging, especially for smaller businesses.
3. Resistance to Change: Employees and leadership may resist new strategies, tools, or processes designed to mitigate internal risks.
4. Complexity in Integration: Implementing internal risk management strategies across all departments may result in fragmented efforts and inefficiency.

Challenges in Managing External Risks

1. Unpredictability: External risks, such as economic shifts or natural disasters, are often unforeseen, making it harder to prepare.
2. Limited Control: External factors are beyond the organization’s control, leaving businesses to react rather than prevent risks.
3. Market Volatility: Global economic shifts, changes in consumer behavior, or regulatory updates can create unpredictable and sometimes severe consequences.
4. Rapid Adaptation: In the face of external risks, businesses may struggle to adapt quickly enough to mitigate the impact on operations or reputation.

These challenges make it all the more important that businesses develop a robust risk management strategy that includes both proactive and reactive measures. So, let’s start by understanding how to determine and evaluate business risks.

Determining Business Risk

To manage risks effectively, businesses must identify, analyze, and assess the likelihood and impact of potential risks. Here’s a breakdown of the steps involved in determining business risk:

1. Risk Identification

Begin by identifying potential risks through assessments and consultations with stakeholders. This step involves:

• Internal Risk Assessment: Reviewing past incidents, understanding industry-specific risks, and considering threats to operations, finances, and reputation.
• Stakeholder Consultation: Engaging with key individuals (management, employees, suppliers, etc.) to identify concerns and emerging risks.
• Risk Categorization: Grouping risks into categories (financial, operational, strategic, reputational, etc.) to aid prioritization.
  Examples:
  • Financial Risk: Risks related to currency fluctuations, credit risks, or liquidity shortages.
  • Operational Risk: Risks such as system failures, supply chain disruptions, or workforce issues (e.g., staffing shortages or skill gaps).
  • Strategic Risk: Risks arising from shifts in market dynamics, new competitors, or failed strategic initiatives.
  • Reputational Risk: Risks linked to brand damage, public relations crises, or customer dissatisfaction.

Early identification of these risks allows businesses to develop targeted strategies to minimize potential negative impacts.

2. Risk Analysis

After risks are identified, the next step is to analyze them to understand their potential impact on the organization. This analysis is done using three primary methods:

• Qualitative Analysis: Assesses risks based on descriptive measures. Risks are rated on scales like Likelihood (High, Medium, Low) and Impact (High, Medium, Low). A Risk Matrix is often used to plot these risks visually, allowing for quick identification of the most critical ones.
• Quantitative Analysis: Uses numerical data and historical patterns to calculate the probability and financial impact of risks. Example: Using past recall data, a company might estimate the cost of a potential product recall. This method is particularly useful for assessing risks with measurable financial consequences.
• Scenario Analysis: Examines different “what-if” scenarios to assess how changes in variables could affect the business.  For example, a company might analyze the potential outcomes of an economic downturn or changes in market conditions to determine how these changes could impact its operations.

By employing these methods, businesses can gain deeper insights into the risks they face. This allows them to prioritize risks based on their potential impact and likelihood.

3. Calculate Risk Score

The risk score is a measurable value that combines both the impact and likelihood of a risk. Different formulas are used to calculate this score, depending on the context and the specific needs of an organization or the type of risk being assessed. These formulas include:

• Risk Score = Likelihood × Impact
• Risk Score = Probability of Event × Magnitude of Loss
• Risk Score = Likelihood × Severity × Detection 

The formula chosen depends on the situation and the aspects of risk that are most pertinent to the organization or industry:

• Likelihood × Impact: Commonly used in general risk assessments across various fields.
• Probability of Event × Magnitude of Loss: Typically applied in financial risk management and insurance sectors.
• Likelihood × Severity × Detection: Used in engineering, manufacturing, and healthcare, particularly for Failure Mode and Effects Analysis (FMEA).

Each formula is tailored to the specific type of risk analysis being conducted, ensuring that the most relevant factors are taken into account.

Now, let’s explore the best practices for ensuring efficient management of risk.

Best Practices for Maintaining Efficient Risk Management

To ensure efficient and proactive risk management, businesses should follow these best practices:

1. Regular Updates and Reviews: Risks evolve over time, so it’s essential to regularly update your risk assessments. This includes reviewing risks after major organizational changes, product launches, market shifts, or regulatory updates.
2. Continuous Monitoring: Automate risk monitoring to stay updated in real time. Use advanced tools to track both internal and external risks continuously. This helps identify issues before they escalate.
3. Cross-functional collaboration: Involve all departments in the risk management process. Collaboration between HR, IT, finance, and other teams ensures that no risk is overlooked, creating a more comprehensive risk management strategy.
4. Leadership Involvement: Strong leadership is key to defining the company’s risk appetite and guiding strategic decisions. Their active involvement ensures that risk management aligns with the company’s broader goals.
5. Risk Diversification: Avoid putting all resources into one area that could be at risk. Diversify investments, markets, and product offerings to spread the potential impact of risks and reduce overall exposure.
6. Clear Communication: Maintain open and transparent communication across all levels of the organization. Ensure that employees are informed about potential risks and the company’s strategies to manage them, fostering a culture of awareness and preparedness.

By adopting these best practices, businesses can proactively identify, assess, and mitigate risks while strengthening their overall risk management framework. Technology can play a crucial role in supporting these efforts, making it easier to manage risks with greater efficiency and precision. Let’s see how tools like VComply can help optimize your risk management processes.

Streamline Risk Management with VComply

VComply is a comprehensive risk management platform designed to streamline and strengthen your organization’s approach to managing risks. With a range of features aimed at improving risk identification, assessment, and mitigation, VComply helps businesses proactively manage risk across various departments and processes. Here’s how VComply supports effective risk management:

1. Centralized Risk Register: VComply provides a centralized risk register that allows you to catalog and monitor all identified risks in one place. This makes it easier to track the status of each risk, assign responsibilities, and ensure that risks are continuously monitored.
2. Automated Risk Assessments: It simplifies risk assessments by automating the process, allowing you to quickly assess and evaluate risks based on pre-set criteria. This ensures that risks are consistently evaluated and helps you make data-driven decisions on how to mitigate or manage them.
3. Risk Reporting and Analytics: With VComply’s reporting and analytics tools, you can gain valuable insights into your organization’s risk landscape. It offers customizable reports that highlight key risk areas, trends, and risk exposure, enabling you to make more informed decisions about risk mitigation strategies.
4. Collaboration and Communication: Effective risk management requires collaboration across departments. VComply facilitates seamless communication between teams by allowing stakeholders to collaborate on risk mitigation plans, share updates, and track progress. This ensures that everyone involved is on the same page.
5. Compliance and Policy Management: It also helps businesses stay compliant by integrating risk management with policy and compliance management. This ensures that risks related to regulatory requirements, internal policies, and industry standards are addressed as part of the overall risk management process.

With these features, VComply empowers organizations to efficiently manage risks, stay compliant, and maintain a proactive approach to risk mitigation. 

Take advantage of VComply’s ready-made templates to standardize and communicate risk management policies. Our templates ensure that your risk guidelines are clear, consistent, and accessible across the organization—making it easier for everyone to stay informed and compliant.

Start your free demo today and discover how VComply can streamline your risk management strategy, ensuring a more resilient and responsive business.

Conclusion

Managing business risks is an ongoing process that requires a structured, systematic approach. By gaining a clear understanding of potential risks, decision-makers can prioritize them, allocate resources efficiently, and take proactive actions to safeguard business continuity.

While it may not be possible to eliminate all risks, a proactive and adaptable risk management strategy can help businesses minimize potential damage and maintain stability in the face of uncertainty. 

Ready to streamline your risk management process?