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How well do you know your risks? As Reid Hoffman, an American entrepreneur and LinkedIn co-founder, once said: “Everything in life has some risk, and what you have to actually learn to do is how to navigate it.”
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So, whether in your personal life or business, every activity involves some level of risk, and you just have to consider it. Of course, the bigger the potential reward or value of your aim, the greater the risk usually is. Nevertheless, the main takeaway is that, regardless of the risk's scale, it is unavoidable.
The key, then, is to learn how to manage and minimize the risks commonly associated with the activities you perform by first recognizing that these risks even exist and then understanding their magnitude. This is where the concept of inherent risk comes into play.
What is inherent risk?
In basic terms, inherent risk is the natural risk associated with any process or activity before you add any controls or safety measures. So, to measure inherent risk is to assess how risky something is on its own, without any safety nets in place. Once you recognize the scale of a given inherent risk, you can then determine how much you can reduce that risk with the appropriate controls, policies, and resources.
To measure inherent risk, an organization needs to go through a thorough process that involves risk identification (discovering activities that could pose risks) and risk evaluation (determining how serious the potential impact could be), examining the risks in their raw form. Once you’ve established this baseline, you can decide where to add new controls and policies to manage the inherent risks effectively.
Does the term “inherent audit risk” ring a bell?
If so, that’s because inherent risk is one of the key components of overall audit risk. Audit risk is a term that usually refers to the risk that the company’s financial statements can be materially misstated and the auditor fails to detect these misstatements, leading to a misleading audit opinion. Audit risk consists of three elements:
Detection risk: The risk that the auditor’s procedures will fail to identify a mistake in the financial statements.
Control risk: The risk that the company’s own controls won’t identify or prevent mistakes in its financial statements.
Inherent risk: The risk of mistakes caused by the nature of the business or industry before any controls are put to use.
Knowing about these risks helps auditors plan and carry out their work more effectively, so they can give a trustworthy opinion on the company’s financial statements.
Which industries have high inherent risk?
Generally speaking, industries that are heavily regulated tend to face higher inherent risks. For example, the financial services sector is quite exposed due to its need to navigate market fluctuations, regulatory compliance, and cybersecurity threats. Similarly, the oil and gas industry contends with environmental regulations, geopolitical uncertainties, and various operational hazards. The IT and cybersecurity sector also grapples with rapid technological changes, intellectual property issues, and persistent cybersecurity threats.
But it’s not just these high-profile sectors. Most industries, whether it’s agriculture, travel, healthcare, or any other field, deal with their own sets of inherent risks. What’s important is to recognize these risks in your daily processes and have strategies in place to address them effectively.
Inherent risk vs. residual risk
There's another key term in risk management that pairs with inherent risk—think of it as the yang to inherent risk's yin—and that's residual risk. Simply put, residual risk is the level of risk that remains after you've applied controls or mitigating measures. In other words, it helps you gauge how much of the inherent risk you’ve reduced or eliminated, and how much is still left to address.
So, to sum it up quickly, inherent risk is the natural level of risk before you do anything to prevent it, while residual risk is what's left after you've taken steps to manage the inherent risk.
Popular inherent risk examples
Risk is part of almost everything we do, so the examples of inherent risk are practically endless. But when it comes to managing risk in a business setting, there are a few key areas that really stand out. Here are some important ones to keep an eye on:
Insufficient audit processes: Without thorough audits, companies may fail to identify internal weaknesses or compliance issues, putting their whole operation at risk.
Security incidents caused by human error: Mistakes made by employees, such as mishandling sensitive data or falling for phishing scams, can lead to significant security breaches, resulting in financial losses and damage to the company's reputation.
Management's failure to uphold operational standards: Without the right processes from management, things can get pretty disorganized. This often leads to poor-quality work, reduced productivity, and non-compliance with industry regulations.
Financial interactions between related businesses: The value of an asset in financial transactions between related parties, like subsidiaries or affiliates, might be reported incorrectly, leading to financial discrepancies and compliance issues.
All online activities are inherently risky
No matter what you do online, there's always some risk involved. This is especially important for businesses to keep in mind. When you're running a company with dozens or even hundreds of employees, all using company accounts and accessing company resources, you're dealing with many different types of inherent risk. People make mistakes—they click on malicious links, use weak passwords, or share credentials in ways they shouldn't (like on sticky notes or via email).
So, how can you mitigate such risks? One option is to use NordPass Enterprise. It's more than just an encrypted password manager—it's a cybersecurity solution that helps you manage access to company resources, enforce strong password policies across your organization, give your employees tools to securely share data, and even check if their information has been compromised in a data breach.
If you want to reduce the risks that come with modern business, give NordPass Business a try and see how it can enhance both your cybersecurity and productivity.