Effective risk management requires proactive identification and prioritization. This is where a tool like a risk matrix can help you and your team.
In this guide, we will cover different types of risk matrix and how you can use them effectively in strategic planning and risk management.
TL;DR
- Risk Matrix is a risk assessment tool to visualize internal and external threats and dangers to projects and organizations.
- They utilize two elements to analyze risk—the likelihood of occurrence and the severity of the consequences on the company.
- You can choose between 3x3, 4x4, or 5x5 matrix to assess the risk.
- Pros: Risk matrix frameworks are customizable and adaptable, making them perfect for projects, team assessments, and company strategic overviews.
- Cons: Risk matrices don’t consider how risks can evolve over time and only give organizations a snapshot of risk probability and severity.
What Is a Risk Matrix?
A Risk Matrix is a strategic planning tool to visualize organizations' different internal and external risks.
They also help to determine:
- The likelihood of the risk affecting the organization
- The potential impact of the risk on the organization
They are an efficient method of risk evaluation, risk control, and prioritizing risk mitigation initiatives.
Depending on the depth of analysis and organizational needs, risk matrices can vary in size—either 3x3, 4x4, or 5x5.
However, all risk matrix frameworks use the probability of occurrence (Y-axis) and level of severity (X-axis) to measure the impact of risks on organizations.
3 Types of Risk Matrix
3x3 Risk Matrix
A 3x3 Matrix grades risk into three levels. This framework is ideal for smaller businesses, projects, or focus areas to identify risk priorities and assist decision-making. Here’s an example:
Severity: marginal, moderate, and critical
Probability: improbable, occasional, and probable
4x4 Risk Matrix
A 4x4 Matrix will assess risk probability and severity on a scale of four. The addition of an extra criterion is helpful for certain businesses that need to prioritize risk mitigation strategies. Here’s an example:
Severity: negligible, marginal, critical, and catastrophic
Probability: improbable, remote, probable, and frequent
5x5 Risk Matrix
A 5x5 Matrix uses five levels to assess the probability and severity of the risk. This framework suits complex or large organizations that want to perform an in-depth risk analysis. Here’s an example:
Severity: negligible, marginal, moderate, critical, and catastrophic
Probability: improbable, remote, occasional, probable, and frequent
5 Different Types of Risks
Every business has threats and dangers that need to be mitigated. Here are some types of risks that most organizations must consider:
Reputational risks
This is a danger to how the organization is perceived by the market, shareholders, and government bodies. For example, negative publicity, poor stakeholder relations, or a change in public perception of the company.
Operational risks
These are potential dangers associated with the breakdown of internal processes, resources, or systems. For example, human error, data breaches, and litigation.
Strategic risks
These are external threats that would disrupt the business and likely result in a change in its strategic direction. For example, the introduction of new technology, unsuccessful mergers or acquisitions, or the failure of a product.
Compliance risks
These are legal, policy, and regulatory risks that will negatively impact the organization and result in fines, litigation, and loss of opportunity. For example, failing to submit audited financial statements on time or not adhering to government regulations.
Financial risks
These are internal and external risks associated with an organization’s financial operations that can result in financial loss. For example, a lack of liquidity during a recession or the failure to pay back debtors on time.
How to Use a Risk Assessment Matrix?
As an example, our step-by-step guide shows how to create a 5x5 Risk Matrix, but the process can be applied to any version.
1. Identify risks
The first step is performing an internal analysis to identify all risks in the organization or focus area. Then, look at the organization’s external environment and identify potential threats and dangers.
This may require in-depth research and input from thought leaders, specialists, and industry professionals. If you’re part of a large organization, you’ll likely need to bring other key role players on board in this process.
Risk management can’t be left up to one person or sidelined. It’s vital to involve different stakeholders and perspectives in risk assessment processes. In this way, you'll be able to see what's going on on the front line, which can help you assess the risk factors more accurately.
Here are some questions that can guide you through this step:
- What are our organizational strengths and weaknesses?
- Has the organization experienced specific issues in the past?
- What keeps our management team up at night?
- What or who are our most valuable assets?
- Where are we experiencing inefficiencies and losses?
- Who knows this area of the business best?
After identifying potential risks, assign each one a title and meaningful description.
Tip: You can use different strategic analysis tools during your analysis process, including SWOT Analysis, PESTLE Analysis, or Porter’s 5 Forces.
2. Determine the impact and probability criteria
Next, look at the factors you’ll use to determine your risk criteria for each identified risk. Assign a score of 1 to 5 based on your risk rating criteria and research.
Here’s an example of what a scale of impact criteria might look like for a business measuring operational risks:
Similarly, create a table outlining the score criteria for the probability of the risk happening. Here’s an example:
Work with other key stakeholders in your business to determine how you should rate various risks and what questions you should ask to determine scores.
For example, if you assess the probability and impact of financial risks, include your CFO and accounting team to benefit from their subject matter knowledge.
When scoring the probability and impact of risks, you can use these questions in your process:
- How likely will this risk affect us?
- Are there existing plans to deal with this risk?
- Is the organization/team/department aware of this risk?
- Have other businesses in our industry been affected?
- Is the threat growing or declining?
- How long has this risk existed for the company?
- Is the issue complex or easy to solve?
- Do we have the requisite resources to resolve the problem?
- Why does this problem exist?
- Is the threat or danger isolated, or is it the result of other risks?
3. Calculate risk
Identify each risk's probability and potential impact on operations, finances, strategy, and reputation.
Remember, your score will be based on understanding the risk, the organization, and the external environment.
For example, let’s say an early-stage startup has 3 months of capital but expects to break even in 6 months' time:
- Not securing further investment would be rated 5 (Catastrophic - High risk).
- If they had 12 months of capital, the risk impact might be rated 3 (Critical - Moderate risk).
- Similarly, if the company has recently signed a partnership deal that will increase its revenue by 120% next month, the risk impact might only be 2 (Marginal - Low risk).
Do this by assigning a score based on your criteria for each risk’s probability and impact. Then, calculate the risk score using Excel or Google Sheets. The risk score will indicate your level of risk and which threats and dangers must be prioritized.
The risk formula goes like this: Level of Risk = Probability x Impact
Here’s an example:
Then, plot them onto your 5x5 Risk Assessment Matrix. Your probability score will correspond with the vertical axis and your impact score will be plotted on the horizontal axis. Here’s an example:
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4. Prioritize risk mitigation initiatives and prepare a plan to reduce risk
Now that you have your 5x5 Matrix filled in, it’s clear which risks must be prioritized by the organization.
You’ll need to create a strategy to address these issues and institute risk management initiatives to reduce the potential risks that pose the highest threat.
This strategy should include:
- Urgent control measures to address high-risk issues to the business
- An action plan to reduce the probability and impact of prioritized risks
- A long-term strategy to improve the business's overall risk level
- A contingency plan to deal with worst-case scenarios
5. Implement your plan and monitor progress
Execution is crucial to any effective strategic risk management process. Part of this activity involves monitoring the progress and success of risk mitigation projects.
An example of risk management and reporting in Cascade
Make sure you continue to assess risks as the risk landscape evolves and adjust your plans accordingly. You should perform a risk assessment a few times per year as a best practice.
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Risk Matrix Example
Here’s an example of a 4x4 Risk Matrix produced by McKinsey & Company to visualize risks associated with cyber security and online businesses. Chief risk and information security officers identified critical assets, known risks, and potential new risks.
In this example, these four risks are:
- Service disruption
- Data leakage
- Cyberfraud
- Vendor Cyber Risk
After identification, internal and external teams assessed the likelihood of occurrence and impact, resulting in the following matrix:
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As a result of this risk assessment matrix, risk owners prioritized the following risk management strategies, starting with the worst-case scenario:
- Data Leakage
- Cyberfraud
- Vendor Cyber Attack
- Service Disruption
Benefits of Risk Matrix
The benefits of Risk Matrix are:
- Relatively easy to use and understand
- Presents data in a clear and accessible way
- Ability to customize the framework to your business
- Helps strategic planners identify and prioritize risks
Disadvantages of Risk Matrix
The disadvantages of risk matrix are:
- It’s based on qualitative assessments and it can lead to sub-optimal resource allocation
- May create a false sense of security around risks
- In some cases, categories may not be specific enough to assess risks accurately
- Often oversimplified
- Does not consider how risks can change or evolve over time
Where and When Should You Choose a Risk Matrix Framework?
Risk assessment matrix frameworks are typically used during project planning risk evaluations. However, they can also benefit strategic planners who want to understand organizational efficiencies, business priorities, and growth potential.
Because they are very customizable, they can be tailored to various purposes, such as small projects, company overviews, and long-term market assessments.
Any business leader, portfolio manager, or project manager who wants to identify risks and formulate action plans to address them should consider using this framework.
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- Set objectives, projects, and KPIs
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