What is a Risk Rating?

When 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 economical or reputational, and its likelihood of occurring shortly. 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 rated as low/medium risk.Medium: An event resulting in risks that can cause an impact but not a serious one is rated as medium.Medium/High: Severe events can cause a loss of business, but the effects are below a risk rated as high.High: A major event that can cause reputational and economic damage, resulting in huge business and client base losses.

Likelihood Rating

This rates the risk based on its recurrence, which can change depending on the type of 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.

  • FrequentLikelyPossibleUnlikelyRare

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Risk Rating Example

Below is an example of the Risk rating based on 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. Businesses with lower income can have $500k as a high-risk event, whereas higher-income businesses will rate it as a low-risk event. The rating purely depends on the sector in which the business is operating.

Likelihood Rating

Advantages

  • Studying the risk involved in a business activity helps in taking appropriate measures to either curb the effects of the risk or 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, resulting 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 regarding reputational or economic damage to an organization or a sector.Organizations should consider conducting at least a yearly risk rating review 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 on the business, along with the likelihood of the event’s occurrence.

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

  • Systematic Risk DefinitionDownside Risk MeaningInherent Risk Examples