Once you have identified a comprehensive list of risks and estimated their impact value and likelihood they will need to be prioritised. RISK PRIORITISATION is a way of optimising the resources you will require for the risk management process. Businesses are always resource constrained and therefore you need to focus the limited resources on the more important risks to the success of the business.
Risk importance can be estimated using a very simple formula:
Value x Likelihood = Importance
I often refer to this as the V&LI (pronounced ‘valley’) formula using the initials of the key words.
If you entered the impact values in a single numeric currency and the likelihood values as a numeric probability you can place a simple formula into the importance column of your spreadsheet (V x L). The spreadsheet can then calculate a estimated importance value for each of the risks identified.
Using the sorting option of your spreadsheet software will allow you to sort all the risks you have identified based on their importance. Aim to sort them so that the most important risks are at the top of the list. These are the ones which, if necessary, will justify the use of more resources to evaluate and manage them.
The percentage of risks which are considered to be important enough for more detailed analysis and management is a judgemental process. It depends upon how detailed your risk identification process has been and the materiality of the values impacted by the risks compared with the overall value of your part of the business.
When I was managing my own businesses I had a fairly simple criteria for deciding which risks were important enough to be carefully managed – if my boss needed to be informed when a risk went ‘wrong’ it definitely needed to be on the list. If you own the business substitute the boss with your spouse! Generally any risk which could impact 5% of the annual profitability of your business is significant and for more sensitive shareholders this could go down to 2% or even 1%.
Once the sorted list of risks has been reduced to a workable number based on the significance of their importance to the business you can move on to the risk analysis and management action plan stage. The link for this is here.
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