Once the risk has been identified and quantified, the process of risk treatment is started which involves decisions on whether particular risks should be transferred, avoided, reduced or accepted.
A risk can be transferred wholly or partly through methods such as insurance, outsourcing, and hedging. An organization might choose to avoid the risk, However, it’s important to remember that with nothing ventured comes nothing gained. Reduction involves mitigating either the likelihood or the impact of the risk by establishing internal control mechanism. Acceptance of risk is appropriate where adverse effect is minimal.
“TARA” mnemonic is used to remember above mentioned techniques for risk treatment.
If we think about crossing a road, we face a risk of being killed or seriously injured by a vehicle. We all go through a quick mental process to assess the risk and take appropriate action. Firstly, we do not realize the risk then we leave things completely on chance which is very dangerous approach. Secondly, if we realize the risk then automatically consider the road’s width and speed of traffic etc. Then we perform rough mental calculations that weigh all the factors and assess the risk. As individuals, we do not avoid the risk of crossing road. However, we might mitigate it using pedestrian bridge or by using Zebra crossing at road signal.
BrightStar is a private limited company, which manufactures lady fashion products. The company has a significant amount of trade receivables that are material to financial statements. The categories of trade receivables and risk associated with them are as follows:
- Small retail shops which represent nearly two-thirds of total receivables. Some of these customers pay after three months and majority pays slowly with installments.
- Chain of shopping malls that sells the only range of clothes. Some of these accounts are large are overdue.
Considering risk treatment, the company’s management may decide to transfer risk by having insurance of irrecoverable debts or minimize risk by implemented internal control like performing credit checks while the selection of new customers.