Enterprise Risk Management – Intro
We’ve already discussed internal controls. The framework for internal controls was established in 1992, and since then, COSO has recognized the significance of risk assessment for businesses. As businesses become more complex and global, the risks increase. They wanted to develop a complete framework dedicated to risk management.
That’s why we have Enterprise Risk Management (ERM), also established by COSO. It includes various components and principles, and we’re going to explore how it differs from the Internal Control Framework and how it supplements the Internal Control Framework.
To emphasize, the ERM framework does not replace the Internal Control Framework. The two work in tandem. Think of it this way: the Internal Control Framework is like the foundation, and the ERM framework builds on that foundation. The ERM framework doesn’t replace any elements of the Internal Control Framework; rather, it adds to it, making it more robust. Imagine the illustration of a pyramid.
With that in mind, let’s examine what makes the ERM framework distinct from the Internal Control Framework.
The primary idea behind the ERM framework is that an entity exists to provide value for its stakeholders. The better an entity manages its risks, the better it manages the company’s value.
There are four aspects of value in ERM:
• Value Creation
• Value Preservation
• Value Erosion
• Value Realization
Value creation means the company embarks on new areas that allow for increased value, such as launching a new business segment that will generate new value.
Value preservation refers to maintaining the areas of operation that the company already has. If the company has a successful product line, it needs to preserve that value and prevent it from eroding.
Value erosion is when value is not preserved, like when an existing product line no longer provides value to the company.
Lastly, value realization is when the company experiences financial benefits from its operations. This means that value doesn’t just translate into improved efficiency but leads to clear financial benefits.