ZenGRC Team

Inherent risk and control risk are two of the three parts of the audit risk model, which auditors use to determine the overall risk of an audit. Inherent risk is the initial risk related to the company’s business activities without considering internal controls and their impact on the overall risk rating of those activities.

Control risk, on the other hand, is the chance of a risk materializing due to a failure in the set of controls placed by the business. For example, material misstatements could appear while preparing a company’s financial statement due to a lack of relevant internal controls to mitigate a particular risk.

There is a distinct difference between inherent risk and control risk. The inherent risk stems from the nature of the business operation without implementing internal controls to mitigate the risk. Control risk arises because an organization lacks adequate internal controls to prevent and detect fraud and error.

Every business transaction has a high, medium, or low risk that companies should mitigate via internal controls. However, just implementing an internal control system isn’t good enough.

Inherent risk and control risk are essential concepts in risk management. By nature, business actions are subject to various risks that can diminish the positive effects they can bring to a company.

The third component of the audit risk model is detection risk, which is the risk that the auditors won’t detect a material misstatement in an organization’s financial statements.

Explaining the Three Elements of Audit Risk

Audit risk is the risk that a company’s financial statements are materially incorrect, even though the auditors state that the financial statements don’t contain any material misstatements.

The purpose of an audit is to cut the audit risk to an acceptable level. During an audit, the auditors examine the audit’s inherent and control risks while also understanding the company and its environment.

Consequently, auditors have to do a risk assessment of each component of audit risk and ensure the accuracy of the information in the financial statements. Since investors, creditors, and others depend on the financial statements, audit risk may carry legal liability for a Certified Public Accountant (CPA) firm that conducts the audits.

Audit risk is usually considered the product of the various risks that auditors may find when they conduct audits. That is, audit risk = inherent risk x control risk x detection risk.

Inherent Risk

Inherent risk is looked at as untreated risk, i.e., the natural level of risk inherent in a business process or activity before the company implements any procedures to reduce the risk. This is the amount of risk before a company applies any internal controls.

One key factor that brings about inherent risk is how a company conducts its day-to-day operations. A company that can’t cope with a rapidly changing business environment and indicates that it’s unable to adapt could increase the level of inherent risk.

Another issue that could increase the inherent risk level is how a company records complex transactions and activities. A company collecting data from several subsidiaries to combine that information later is considered engaging in complicated work, which could comprise material misstatements and give rise to inherent risk.

In addition, inherent risk can be increased because of the lack of integrity of a company’s management. A company can mitigate inherent risk by implementing internal controls.

Examples of Inherent Risk

• Lack of integrity in the company’s management. Company leadership engaging in unethical business practices could negatively affect the company’s reputation, leading to a loss of business and increasing inherent risk.
• Inadequate audits. Previous weak, biased audits or in which auditors intentionally ignored misstatements could increase the risk of material misstatement.
• Transactions between related entities. There’s a chance that the asset’s value involved in any financial deal between the associated parties might be overstated or understated.
• Cybersecurity breach due to human error. Employees entering the workplace or accessing papers often utilize tags and key passes. These key passes and tags might be stolen or lost and used to gain unlawful access to the business infrastructure, creating information security risks.

How do you Identify Inherent Risks?

The presence of inherent risk is unavoidable. This means that any company is vulnerable to inherent risk. The odds of inherent risk are minimal when a corporation has a simple corporate structure. However, more sophisticated organizations with convoluted structures have greater inherent risk.

Companies working in highly regulated industries, as with financial institutions, are more likely to have higher inherent risk, notably if the business needs a team of internal auditors or an audit department lacking an oversight group with a financial background.

Auditors can utilize inherent risk to identify prospective threats, the likelihood of an incident, and the potential impact. When looking for the risk profile of your company, take into consideration the following risk factors:

• Business Type
• Execution of Data Processing
• Complexity Level
• Management Style and Reliability
• Previous Audits

Control Risk

Control risk is the likelihood of loss stemming from the malfunction of the relevant internal controls a company implements to mitigate risks or the absence of those appropriate internal controls altogether.

Control risks happen because of the limitations of a company’s internal control system. If the internal control systems aren’t reviewed periodically, they will likely lose effectiveness over time.

In a financial environment, control risk is the chance that financial statements are materially misstated because of failures in a company’s system of internal controls.

If there is a significant control failure, an organization will probably suffer undocumented asset losses, i.e., its financial statements might identify a profit although there’s a loss.

An organization’s leadership is responsible for designing, implementing, and maintaining a system of internal controls that can adequately prevent the loss of assets. However, it’s not easy for a company to maintain a solid system of internal controls.

Management should review the internal control system annually and update the internal controls to fit ongoing changes in the business.

The following elements increase control risk:

• There’s no segregation of duties.
• Documents are approved without management review.
• Transactions aren’t verified.
• The supplier selection process isn’t transparent.

Companies should decide what type of internal controls to implement for each risk based on the likelihood of the risk and the amount of financial loss if the risk does occur.

A risk’s likelihood and impact can be high, medium, or low. A company that thinks it’s highly likely that a particular risk will occur and cause significant financial loss should implement highly effective internal controls.

Companies develop internal controls to manage inherently risky areas. An organization might implement internal controls to decrease the risk that payables are understated.

Examples of such internal controls include:

• The chief financial officer reviews the payables details at the end of each period and determines if the list is complete.
• The payables manager reviews all the invoices entered into the payables system.
• The payables manager asks all payables clerks about unprocessed invoices at the end of the period.
• Department heads review the budget-to-actual report.

Inherent risk exists independent of internal controls. Control risk exists when the design or operation of a control doesn’t eliminate the risk of a material misstatement.

But even after a company implements the required internal controls, there’s no guarantee that the risk can be removed entirely. As such, part of the risk might remain. This type of risk is known as residual risk, as it is the risk that remains after the company implements the internal controls.

Detection Risk

Detection risk is the risk that the auditors’ procedures cannot detect any material misstatements in a company’s financial statements.

An auditor uses the audit risk model to understand the relationship between the detection risk and the other audit risks, i.e., inherent risk, control risk, and the overall audit risk, enabling him to determine an acceptable level of detection risk.

Although detection risk can’t be eliminated totally, the auditor can reduce it by modifying certain factors, including:

• The makeup of the engagement team, e.g., the competence and skill of the auditors and the size of the engagement team
• The types of audit procedures, e.g., the degree of substantive procedures compared to the tests of internal controls, the evidence collection procedures, including if the evidence is internally or externally generated
• The rigorousness of the audit procedures, e.g., the sample sizes and the length of the audit engagement
• Quality control, e.g., the CPA firm’s system of quality control and reviews by qualified personnel outside the audit engagement team

Take Control with ZenGRC

As your company grows, you may discover that your risk tolerance shifts. After all, it is your job to operate it, and you may be more daring in some fields now than you were before. On the other hand, maintaining a record of your control, detection, inherent and residual risks can prove too strenuous for spreadsheets or traditional methods.

This is where ZenGRC can assist you. ZenGRC is a governance, risk, and compliance platform that can help you create, manage, and track your framework for risk management and corrective actions. 

ZenGRC’s risk assessment modules can provide valuable insight into areas in which your documentation falls short, allowing you to take quick action to collect the necessary evidence.

Schedule a demo and get started on the path to worry-free risk management.

Threat, vulnerability, and risk – these words often appear side by side in security discussions. But what exactly do they mean, and how do they differ from one another?

This article discusses the relationships among threats, vulnerabilities, and risk. Then we’ll explore various methods for calculating and managing these issues, and provide insights into securing against potential security threats.

How do Threats, Vulnerabilities, and Risk Differ?

Threats, vulnerabilities, and risk are important concepts within cybersecurity and information security. Here’s a brief explanation of each term.

Threats

A threat refers to any potential danger or harmful event that can exploit a vulnerability and cause harm to a system, organization, or individual.

Threats can be intentional or unintentional in nature. Intentional threats are deliberate actions or attacks carried out by threat actors with malicious intent. These can include cyberattacks, such as malware infections, malicious code or SQL injection attacks, ransomware, phishing attempts, and distributed denial-of-service (DDoS) attacks.

On the other hand, unintentional threats originate from human error or accidental actions that can lead to security breaches. These threats include accidental disclosure of sensitive information or falling victim to social engineering tactics.

Vulnerabilities

A vulnerability is a weakness or flaw in an operating system, network, or application. A threat actor tries to exploit vulnerabilities to gain unauthorized access to data or systems. Security vulnerabilities can arise for many reasons, including misconfigurations, design flaws, or outdated software versions.

Common vulnerabilities include software vulnerabilities (that is, bad code), easily guessable passwords, unpatched systems, lack of encryption, insecure network configurations, and human error such as falling for phishing scams or sharing sensitive information unintentionally.

Risk

Risk is the likelihood of a threat exploiting a vulnerability and causing harm. It represents the potential loss or damage associated with a specific threat.

Cyber risk encompasses the potential financial, operational, legal, or reputational consequences of a successful cyberattack or data breach. Risks can vary depending on the specific threat landscape, the value of the assets at risk, and the effectiveness of existing security controls.

Organizations employ risk management processes and methodologies to identify, evaluate, and prioritize security risks. Risk assessment is the systematic identification of potential cybersecurity threats, vulnerabilities and their associated impacts; and risk assessment is one of the most important parts of risk management. Risk assessment helps organizations to understand their security posture, prioritize resources, and make informed decisions regarding risk mitigation.

How to Calculate Threat, Vulnerability, and Risk

To calculate threat, vulnerability, and risk, one must assess potential dangers and understand how susceptible your systems or assets are to harm. Here’s how you can perform those calculations.

1. Threat. To calculate a threat, consider the probability of an event happening and the severity of its impact. Analyze historical data and trends to assess the chances of a threat materializing.
2. Vulnerability. To calculate vulnerability, evaluate the effectiveness of security measures and controls you have in place. Then, assess the strength of the security systems, access controls, and training programs you invested in. Identify any vulnerabilities discovered through assessments or audits.
3. Risk. Calculate risk by multiplying the likelihood of a threat occurring by the damage it would cause. This helps you to prioritize risks and allocate resources efficiently. Use qualitative or quantitative assessments, such as a risk assessment matrix, to visually represent your organizational risk analysis.

Managing Threats, Vulnerabilities, and Risk

The following steps can help organizations to enhance their cybersecurity posture:

1. Assess. Conduct regular assessments to identify and understand potential cyber threats and vulnerabilities within the organization’s systems, networks, and infrastructure. This involves analyzing potential risks, evaluating their effect on sensitive data, and identifying areas that need immediate attention.
2. Plan. Develop a risk management plan that outlines the organization’s approach to addressing cyber threats and vulnerabilities. This plan should include specific strategies, policies, and procedures to mitigate risks, protect sensitive data, and enhance network security.
3. Protect. Implement robust security and authentication measures to protect against cyber threats and hackers. This includes deploying firewalls, anti-virus solutions, intrusion detection and prevention systems, and secure configurations for all network devices.
4. Educate. Conduct regular training programs to educate your security teams and employees about cybersecurity best practices. This includes raising awareness about common security threats, sharing password management best practices, and educating employees about social engineering techniques employed by cybercriminals.
5. Monitor. Implement continuous monitoring systems to detect any potential security threats or vulnerabilities in real time. This can involve deploying security tools that provide visibility into network traffic, monitoring system logs, and implementing security information and event management (SIEM) systems.
6. Respond. Develop an incident response and vulnerability management plan that outlines the steps to be taken in the event of a cyber attack or unintentional threats.
7. Test. Conduct regular penetration testing and vulnerability assessments to identify weaknesses in the organization’s systems. This involves simulating real-world cyber attacks to evaluate the effectiveness of existing security controls and detect areas for improvement.
8. Collaborate. Foster collaboration among different teams and stakeholders, such as the IT department, security teams, and executive leadership. This assures a coordinated effort to tackle cyber threats, share information, and make timely decisions to strengthen the organization’s security posture.
9. Evaluate. Continuously assess the effectiveness of the organization’s cybersecurity measures. Conduct audits, review incident response processes, and measure security KPIs to make better decisions that would improve the overall organizational security posture.

ZenGRC Helps Businesses Assess and Minimize Threats, Vulnerabilities, and Risks

The ZenGRC is a cyber risk management solution that provides clear visibility into cyber risk and actions that align with your organization’s key objectives. With ZenGRC, you can connect threats, vulnerabilities, and risks while ensuring continuous control testing and real-time scoring to identify any changes in risk levels promptly.

Sign up for a demo and see how ZenGRC helps you break down the silos that cause inefficiencies and stay ahead of all cyber threats.

In a difficult economic climate, a company’s odds of survival depend on how skillfully it manages risk. A well-rounded risk management strategy can help companies stay in business longer because they can navigate key risks and prepare themselves for potential effects from internal and external conditions.

Understanding what sound risk management practices are, however, is no easy task. This article walks through the basics, so you can implement a smart risk management program at your own organization.

What is Risk Management?

When developing a risk management program, a company typically goes through the following step. Those steps begin with a strategic planning exercise with senior management, and conclude with a business continuity plan.

Risk Identification

The first step is to identify the risks that might threaten your business model or business continuity. The below list is not exhaustive, but it does give you a sense of the threats you should be looking for:

• Operational risk
• Financial risk
• Reputational risk
• Compliance, legal, or regulatory risk

Risk Assessment

Once you identify the risks that might strike your organization, you need to assess the actual likelihood of the risk happening and the possible harm it might cause. This lets you organize your most pressing risks by priority, so you can allocate risk management resources more efficiently.

Risk Treatment (acceptance, avoidance, mitigation, transference)

You can treat different risks in different ways. For example, some companies might decide to accept certain cybersecurity risks, while others might transfer the potential damage (say, by taking out a cyber insurance policy). Still others might avoid the risk entirely (perhaps by not using a certain type of IT asset), and others might mitigate the risk by taking certain precautions to make the risk less harmful.

Risk Monitoring

Risks evolve over time. So once you decide on a risk treatment, you must still monitor your risks to see whether they’ve become better, worse, or gone away entirely. Companies might use a blend of internal controls and external providers to enable active threat monitoring from all risk factors, especially when launching new products or new markets.

Continuous Improvement

Companies should continuously improve their resilience to risk. Those efforts gradually reduce your risk profile, which assures company stakeholders and customers of the company’s long-term prospects. As companies improve at risk management, customer loyalty and retention improve.

All that said, each company needs to find its one approach to risk management. One of the most fundamental issues is whether to take a proactive or reactive approach to risk management.

Proactive and Reactive: What’s the Difference?

Reactive risk management could mean the following:

• Preventing potential risks from becoming incidents
• Mitigating damage from incidents
• Stopping small threats from worsening
• Continuing critical business functions despite incidents
• Evaluating each incident to solve its root cause
• Monitoring to assure that the incident does not recur

On the other hand, proactive risk management strategies include:

• Identifying existing risks to the enterprise, business unit, or project
• Developing a risk response
• Prioritizing identified risks according to the magnitude of their threat
• Analyzing risks to determine the best treatment for each
• Implementing controls necessary to prevent hazards from becoming threats or incidents
• Monitoring the threat environment continuously

Using the terms “proactive” and “reactive” when discussing risk management can confuse people, but that shouldn’t be so; proactive and reactive risk management are different things. Understanding the difference between the two is crucial to developing effective risk mitigation strategies. So let’s understand the nuances of each approach in detail.

The basics are simple. Reactive risk management tries to reduce the damage of potential threats and speed up an organization’s recovery from them, but assumes that those threats will happen eventually. Proactive risk management identifies possible threats and aims to prevent those events from ever happening in the first place.

Each strategy has activities, metrics, and behaviors useful in risk analysis.

Reactive Risk Management

One fundamental point about reactive risk management is that the disaster or threat must occur before management responds. In contrast, proactive risk management is about taking preventative measures before the event to decrease its severity. That’s a good thing to do.

At the same time, however, organizations should develop reactive risk management plans that can be deployed after the event – because many times, the unwanted event will happen. If management hasn’t developed reactive risk management plans, then executives end up making decisions about how to respond as the event happens; that can be costly and stressful.

There is one Catch-22 with reactive risk management: Although this approach gives you time to understand the risk before acting, you’re still one step behind the unfolding threat. Other projects will lag as you attend to the problem at hand.

Helping to Withstand Future Risks

The reactive approach learns from past (or current) events and prepares for future events. For example, businesses can purchase cybersecurity insurance to cover the costs of a security disruption.

This strategy assumes that a breach will happen at some point. But once that breach does occur, the business might understand more about how to avoid future violations and perhaps could even tailor its insurance policies accordingly.

Proactive Risk Management

As the name suggests, proactive risk management means that you identify risks before they happen and figure out ways to avoid or alleviate the risk. It seeks to reduce the hazard’s risk potential or (even better) prevent the threat altogether.

A good example is vulnerability testing and remediation. Any organization of appreciable size is likely to have vulnerabilities in its software that attackers could find and exploit. So regular testing can find and patch those vulnerabilities to eliminate that threat.

Allows for More Control Over Risk Management

A proactive management strategy gives you more control over your risk management. For example, you can decide which issues should be top priorities and what potential damage you will accept.

Proactive management also involves constantly monitoring your systems, risk processes, cybersecurity, competition, business trends, and so forth. Understanding the level of risk before an event allows you to instruct your employees on how to mitigate them.

A proactive approach, however, implies that each risk is constantly monitored. It also requires regular risk reviews to update your current risk profile and to identify new risks affecting the company. This approach drives management to be constantly aware of the direction of those risks.

What About Predictive Risk Management?

As the name suggests, predictive risk management about predicting future risks, outcomes, and threats. Some predictive components may sound similar to proactive or reactive strategies.

Predictive risk management attempts to:

• Identify the probability of risk in a situation based on one or more variables
• Anticipate potential future risks and their probability
• Anticipate necessary risk controls

Five Risk Management Strategies with Examples

Now that we understand the two main types of risk management strategies, let’s review how companies implement these strategies in the real world. The following real-world examples might not be conclusive, but they can guide your risk management strategy.

1. MVP or Experiment Development: Instead of launching a full product line or entering a new market, companies can launch products in a lean, iterative fashion- the ‘minimum viable product’ – to a small market subsection. This way, companies can test their products’ operational and financial elements and mitigate the market-related risks before they launch to a broader audience.For example, an airline could test facial recognition technology to make security checks faster, but might want to validate privacy and data security concerns first by trying it out at one airport before going nationwide.
2. Risk Isolation: Companies can isolate potential threats to their business model by separating specific parts of their infrastructure to protect them from external threats.For example, some companies might restrict access to critical parts of their software ecosystem by requiring engineers to work at a specific location instead of working remotely (which opens the door to potential cyber threats).
3. Risk-Reward Analysis: Companies may undertake specific initiatives to understand the opportunity cost of entering a new market or the risk of possibly gaining market share in a saturated market. Before taking the initiatives at a broader level, the analysis would help them understand the market forces and their ability to induce or reduce risks with what-if scenarios.For example, a direct-to-consumer delivery company might want to project the anticipated demand for entering the market with faster medical supply delivery.
4. Data Projection: Companies can analyze data with the help of machine learning techniques to understand specific behavioral or threat patterns in their ways of working. These data analysis efforts might also help them understand what second-order effects are lurking because of inefficient processes or lax attention on certain parts of the business.For example, a large retailer might use data analysis to find inefficiencies in its supply chain to reduce last-mile delivery times and get an edge over the competition.
5. Certification: To stay relevant and retain customer trust, companies could also obtain safety and security certifications to prove they are a resilient brand that can sustain and mitigate significant operational risks.For example, a new fintech company might get certified for PCI-DSS security standards before scaling in a new market to build trust with its customers.(For more reading, we have compiled additional suggestions on risk mitigation.)

How ZenGRC Can Help With Risk Management

Covering all aspects of a risk management plan on your own is challenging. ZenGRC is the best way to create an action plan that addresses all your risks and that you can put into practice efficiently.

ZenGRC can help whether you’re working with a reactive or proactive approach to risk management; its intuitive interface can show you which risks need mitigating and how to do it at a glance. It also tracks your workflows and collects the documents you’ll need at audit time, and more.

Have peace of mind by trusting the only reliable way to prepare for big or small risks. Book a ZenGRC demo today!