Generally, risk appetite is defined as the amount of risk an organization is willing to take in the pursuit of its objectives. Risk capacity is a related concept and defined as the amount of risk an organization can experience and survive.
Risk appetite is often described in terms of the measurements of specific types of risk. I.e., how much fraud or credit losses are acceptable. This often results in a challenge: no one wants to experience fraud or credit losses, or frankly any type of undesired event however in reality you will experience these losses, and you will accept them because the cost to reduce the losses is greater. The real issue with this approach is that provide limited utility to Boards and Management for decision making.
An alternative is to measure risk appetite in terms of the impact on business objectives. For example, if a business has an objective of growing sales by 25% next year, they could define their risk appetite as anywhere between 0% growth and 50% growth. Using the measure of growth in sales, different risks can be assessed to determine the potential impact on sales growth. Decisions that create risk can be evaluated by considering both the direct impact on sales growth and the potential impact of the additional risk. The emotional impact of considering acceptable variance in a business objective is considerably different than the emotional impact of being asked to accept a certain amount of an undesired outcome.
When an organization sets the upper and lower bounds, the risk appetite, for a given business metric, it is useful to consider the impact of those thresholds. In our example, growth of less than 0% could mean that the business would lose money on the year, and growth over 50% might exceed the production capacity.
Simplified Risk Management Inc. helps businesses understand and implement value add risk management programs. Afterall, being in business means taking risk every day. The better you do this, the more successful you will be. Our Simplified Approach to Risk Management™ starts with your strategy and helps you identify the most significant risks to success and to find the optimal solutions to manage these risks. Risk appetite based on business performance metrics is a key part of the Simplified Approach to Risk Management™.