Inherent Risk vs Residual Risk

In any business, risks are an inevitable part of the process. Whether it's related to cybersecurity, operations, or third-party suppliers, every organization faces some form of risk. However, not all risks are created equal, and some can be managed better than others. This is where the concepts of inherent risk vs residual risk come into action. These two types of risks are important for understanding how vulnerable a business is and what actions need to be taken to reduce those risks.

In simple terms, inherent risk is the level of risk that exists before any actions are taken to reduce it, while residual risk is the risk that remains even after safety measures or mitigation strategies have been put in place. Both types of risk are important to understand because they guide how businesses plan, assess, and respond to potential threats. Knowing how to manage inherent and residual risks helps organizations minimize damage, avoid financial losses, and protect their reputation. Let’s explore more about inherent risk vs residual risk in this blog.

What is Inherent Risk?

Inherent risk is the risk that exists in any activity, process, or situation before any measures are taken to control or reduce it. It’s the natural level of risk associated with a specific business operation, simply because of its nature.

For example, if a company deals with sensitive customer data, there is always an inherent risk of a data breach, even if no security measures are in place. This is the baseline risk that all businesses face when engaging in an activity.

The goal of identifying inherent risks is to understand the areas where the business is most vulnerable before any protective steps are taken. Inherent risk doesn’t go away; it’s part of the activity. However, by recognizing it early, businesses can create strategies to reduce it and prepare for potential threats.

Importance of inherent risk

It’s important to understand inherent risk because it helps you know where the biggest dangers are before they try to control them. Identifying inherent risks early allows you to plan ahead and take steps to reduce the risks before they cause problems.

How do you identify inherent risk?

To identify inherent risk:

Look at the process: Think about each step in a process and ask what could go wrong without any protections in place.
Think about outside factors: Consider things like market changes or technology that could cause problems.
Check industry standards: Look at what risks are common for other businesses in the same industry.

These steps help find the risks that are already there, even before any actions are taken to reduce them.

Examples of inherent risk

Cybersecurity: A business that stores customer data online faces the inherent risk of a cyberattack or data breach, as the online environment is a prime target for hackers.
Manufacturing: In a factory setting, inherent risks include the possibility of accidents due to machines, hazardous materials, or unsafe work environments.
Finance: In the financial industry, inherent risks include the volatility of the stock market, which can cause significant losses even with careful investment strategies.

In each of these examples, the risks are built into the nature of the business activity. Even without taking action to reduce them, these risks exist.

What is Residual Risk?

Once an organization takes steps to reduce or control inherent risk, there’s still some risk that remains. This is known as residual risk. It’s the remaining risk after all mitigation efforts have been applied. Residual risk is what’s left over, even after actions are taken to prevent or reduce risk.

For example, a company might put strong firewalls in place to protect its data, but there’s still a chance that a hacker could find a vulnerability that bypasses those measures. That remaining risk is the residual risk.

Residual risk helps businesses understand what’s still out there, even after they’ve put measures in place to protect themselves. It’s important because it represents the risk that organizations are left with after doing everything they can to lower the chances of an incident.

Importance of residual risk

Understanding residual risk is important because it helps you know what risks still exist after they’ve done what they can to reduce them. This helps you decide whether the remaining risks are acceptable and if more steps need to be taken, and keep an eye on what still needs to be managed.

How do you identify residual risk?

To identify residual risk:

Look at what’s been done: After putting in place risk controls (like security measures), check if there are still any risks left.
Re-assess the risks: Re-check regularly to see if new risks have appeared or if old risks have been reduced enough.
Ask others: Get input from different teams, such as IT or operations, to get a complete view of the remaining risks.

These steps help identify what risks are still there, even after taking action.

Examples of residual risk

Cybersecurity: Even with strong firewalls and encryption, there’s still the residual risk that an employee might accidentally click on a phishing email and cause a breach.
Manufacturing: After putting safety measures in place, there’s still the residual risk of a rare machine malfunction or an accident caused by an unexpected event.
Third-party risk: Even after checking that a supplier follows security rules, there’s still the residual risk that the supplier might fail to comply at some point.

These are risks that still exist after taking precautions, and businesses need to decide if they are willing to accept them.

Key Differences Between Inherent and Residual Risk

Before looking at the comparison table, it’s important to understand the difference between inherent risk and residual risk. Inherent risk is the risk that comes with an activity or process before any steps are taken to reduce it. It’s the natural level of risk simply because of what you're doing.

Residual risk, on the other hand, is the risk that still remains after you’ve tried to reduce or control the inherent risk. Understanding the difference helps businesses figure out what risks are still there and what needs to be done next. Here's a simple table comparing the two.

Aspect	Inherent Risk	Residual Risk
Definition	The natural level of risk present before any action is taken to reduce it.	The remaining risk after steps have been taken to reduce or mitigate inherent risk.
Cause	Caused by the inherent nature of the activity or process itself.	Caused by limitations in mitigation strategies or controls that don’t fully eliminate risk.
Control	Cannot be controlled or eliminated but can be reduced through mitigation.	Can be controlled and reduced further with additional mitigation efforts.
Timing	Present before any mitigation strategies are applied.	Present after mitigation strategies or controls have been applied
Examples	Cybersecurity threats before implementing protections, accidents in a manufacturing process before safety measures.	Cybersecurity threats after implementing firewalls, accidents that could still happen despite safety measures.
Management Focus	Focus on identifying and assessing the risk level of activities.	Focus on reducing and managing the remaining risk even after initial actions are taken.
Predictability	Can often be predicted based on the activity’s nature (e.g., online sales have inherent fraud risks).	Less predictable; depends on how effective risk controls are in place.
Impact on Business Operations	Direct impact on business operations without any mitigation measures.	Impact is reduced but still exists, posing a potential threat to operations.

Read: Best Risk Management Software for Businesses

How Do You Calculate Inherent Risk and Residual Risk?

To calculate inherent risk and residual risk, start by assessing the potential dangers in a process before any controls are applied. For inherent risk, evaluate the likelihood and impact of risks based on the activity itself, such as handling sensitive data or operating machinery. Once you've implemented risk controls or mitigation strategies, calculate residual risk by reassessing the same risks to see how much has been reduced. The remaining risk after mitigation is your residual risk, and it helps you understand what risks still exist despite your efforts.

Manage Inherent vs. Residual Risk More Effectively with Atlas Systems

Managing inherent risk vs residual risk is important for keeping your business safe from problems that could affect your work, customers, or reputation. Inherent risk is the risk that exists before you take any steps to control it, while residual risk is what’s left even after you’ve tried to reduce it. To handle these risks well, businesses need to regularly check for possible issues, apply the right controls, and keep an eye on how well those controls are working over time.

Atlas Systems can help make this process easier. With solutions like ComplyScore® for third-party risk management and cybersecurity risk assessment tools, you can spot risks early, track them easily, and take action before they grow into bigger problems. These tools give you clear dashboards and automated checks, so you always know where things stand. If you want to manage risks more effectively and keep your business running smoothly, take a look at Atlas Systems’ services today.

FAQs on Inherent Risk vs Residual Risk

Can residual risk ever be higher than inherent risk?

No, residual risk is usually lower than inherent risk. Inherent risk is the risk before you do anything to control it. Residual risk is what’s left after you put safety measures in place. So, it should always be less than or equal to the original risk, not higher.

Can residual risk be quantified?

Yes, residual risk can be measured. After you apply controls, you can assess how much risk remains by looking at the chances of something going wrong and the possible impact. This helps businesses decide if the remaining risk is low enough to accept or if more action is needed.

Can residual risk ever be completely eliminated?

No, it’s almost impossible to get rid of all risk. Even after strong controls are in place, some level of risk will always remain. The goal is to reduce residual risk to a level that is low enough for the business to accept.