Residual risk is defined as whatever risk remains after controls are applied.
It is important to note that inherent risk factors can only be properly assessed after the entity’s key objectives have been defined, and steps have been taken to identify risks that would get in the way of those objectives. Businesses that focus on residual risk alone can have a skewed view of risk.
When it comes to auditing, inherent and residual risk concepts are essential for establishing a baseline view of a company’s risk posture. Keeping your eyes on both categories over time is essential for effective risk management and inherent risk audits.
How do you measure inherent risk?
Inherent risk is measured using a mathematical equation that calculates the likelihood and impact of the risk. The inherent impact is the effect that an event would have on an organization should it occur and is measured in terms of magnitude.
What are the main inherent risk components in business?
- Compliance and Regulatory Risks
- Operational Risks
- Financial and Fraud Risks
- Reputational Risk
Why is inherent risk important?
Knowing both the inherent and the residual risk allows us to focus our activities and prioritize the risks that are the most important, and then begin to discuss control activities with those risks in mind. Not only might we need more controls, but there may be areas in which we have unnecessary controls implemented.
Assessing Inherent Risk
This list includes some of the factors to consider when assessing inherent risks.
- Potential regulatory fines
- Reputational damage, including the loss of existing customers and contracts
- Resources and capabilities of internal management
- Cyber risks
- The nature of your business
- The type of data you hold and why and for whom you hold it.
- The location of your business
- The knowledge of your employees regarding risks
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