Risk Tolerance | AccountingWEB

Risk Tolerance

Determining your tolerance and your appetite for risk are essential steps in managing risk. This is following up to my last post which introduced the ERM framework, its objectives, and components.

Before getting into risk tolerance, it is important to gain an understanding of risk appetite. I think the best way to explain tolerance is to link it to strategy. Strategy helps to determine the acceptable balance between growth, risk and return. This becomes what I call the relationship between strategy and risk appetite.

In reality, strategy guides the allocation of resources based on risk to achieve acceptable returns on investment and maintain growth. The linkage between strategy and risk appetite also helps to align people, processes, and the organization’s infrastructure. It becomes a balance in how the entity functions and operates.

Risk tolerance represents the acceptable level of variation relative to achievement of objectives. Objectives evolve from the strategic process and provide the basis for measurement of progress towards achieving these objectives. Measurement is critical and the level of risk tolerance needs to be aligned with objectives to determine that actual results will fall within the acceptable levels of tolerance. The ability to operate within risk tolerance gives management the assurance that the organization will operate within its level of risk appetite.

What’s risk appetite? I like to point out that there are two components associated with risk appetite. The first component is the likelihood that an event will occur. The second component is if the event occurs, what will be its impact? Starting with likelihood, it is essential to determine whether the likelihood is low, medium, or high. After assessing likelihood, the next step is to determine the degree of impact. Again this can be measured as low, medium, or high. By combining the assessment of the two components it is possible to evaluate whether a potential event falls within risk appetite or exceeds the organizations appetite for risk.

The next step in managing risk is to define an event. In this regard, an event represents an internal or external incident or occurrence that could affect the implementation of strategy or impede the achievement of objectives. Management needs to recognize that uncertainties exist. A determination needs to be made as to when an event could occur as well as the potential outcome from it.

When evaluating the range of potential events, management will need to deal with a range of events from the obvious to the obscure. In addition, it is essential to estimate the potential effects of the event and classify them as either significant or insignificant together with both its qualitative and quantitative range of impact. The final step is to assess the likelihood of occurrence. These evaluations and assessments need to be imbedded into the culture of how the organization operates and manages its business. It has to be a day to day process in contrast to periodically engaging in a risk assessment exercise and calling it risk management.

The next blog post on risk management will discuss some of the internal and external factors impacting risk, evaluation of cost versus benefits, strategic alignment, the variety of event categories, and alignment of strategy.

This blog

Lynn Northrup, CPA, CPIM - Lynn's focus is on building business value for both family-owned businesses and other CPAs. I also specialize in lean accounting, process improvement, internal control, and assessment of audit risk. Other accomplishments include publishing two books, development of self study programs for Bisk Education, and an Adjunct Professorship at Villanova University. My wife Jessica and I live in southwestern Colorado and we look forward to contributing to the AccountingWEB community.

More from this blog

Bloggers crew

Steve Knowles has spent 25 years in business and practice in the UK, but he also worked in the states and the years haven't dulled his way of seeing an alternative view to everyone else, and every day is a new adventure.


Joel M. Ungar, CPA is a lifelong resident of the Detroit area and a graduate of The University of Michigan. He is a principal with Silberstein Ungar, PLLC, a Top 15 auditor of SEC public reporting companies.


Allan Boress, CPA, with over 25 years as a practitioner and consultant to the accounting profession. Mr. Boress is the author of 12 published books in 6 different languages, including a best-seller, The "I-Hate-Selling" Book.


Larry Perry, CPA, CPA Firm Support Services, LLC, is the author of accounting and auditing manuals, author and presenter of live staff training seminars, and author of webcast and self-study CPE programs. He blogs about small audits, reviews, and compilations.

Sandra Wiley, COO and Shareholder, is ranked by Accounting Today as one of the 100 Most Influential People in Accounting as a result of her prominent role as an industry expert on HR and training as well as influence as a management and planning consultant. She is also a founding member of The CPA Consultant's Alliance. Sandra is a certified Kolbe™ trainer who advises firms on building balanced teams, managing employee conflict and hiring staff.

Maria Calabrese, CIR, Human Resources manager for Fazio, Mannuzza, Roche, Tankel, LaPilusa, LLC in Cranford, New Jersey, Maria's topics revolve around the world of: Mentoring, Performance management, and The "Y Generation," a.k.a. "The whY generation".


William Brighenti is a CPA, Certified QuickBooks ProAdvisor, and Certified [Business] Valuation Analyst, operating an accounting, tax, and QuickBooks consulting firm in Hartford, Connecticut, Accountants CPA Hartford.


Ken Garen, CPA, is the co-founder and President of Universal Business Computing Company (www.ubcc.com), a software development firm of high-volume, high-productivity accounting and payroll technology.


Eva Rosenberg, MBA, EA, is the publisher of TaxMama.com, and author of the weekly syndicated Ask TaxMama column. She provides answers to tax questions from taxpayers and tax professionals worldwide.


Amy Vetter, CPA, CITP is the CPA Programs Leader for Intacct Corporation responsible for leading the CPA/BPO Partners nationally.

Brian Strahle is the owner of LEVERAGE SALT, LLC where he provides state and local tax technical services to accounting firms, law firms and tax research organizations across the United States. He also writes a weekly column in Tax Analysts State tax Notes entitled, "The SALT Effect." For more info, visit his website: www.leveragestateandlocaltax.com
Scott H. Cytron, ABC, is president of Cytron and Company, known for helping companies and organizations improve their bottom line through a hybrid of strategic public relations, communications, marketing programs and top-notch client service. An accredited consultant, Scott works with companies, organizations and individuals in professional services (accounting, finance, medical, legal, engineering), high-tech and B2B/B2C product/service sales.

Rita Keller is a nationally known CPA firm management consultant, speaker, author, mentor and blogger. She has over 30 years hands-on experience in CPA firm management, marketing, technology and administrative operations.

Stacy Kildal is the mom of two fantastic kids, an Advanced Certified QuickBooks ProAdvisor, Certified Enterprise Solutions ProAdvisor, Sleeter Group Certified Consultant, a nationally recognized member of the Intuit Trainer and Writer Network, and co-host of RadioFree QuickBooks.
Michael Alter's blog specializes in providing practical advice to those who seek greater profitability and practice management tactics that enhance deeper client relationships.

Sally Glick, CMO, Principal, Marketer of the Year in 2003 and AAM Hall of Famer in 2007, leads a lively discussion of the constantly expanding roles of marketing and the professional marketers that drive this initiative in accounting firms of all sizes.


The IMA Young Professionals Blog features the insights of IMA’s Young Professionals Committee. Committee members share advice and experiences on careers, continuing education, work/life balance, and other issues affecting young accounting and finance professionals.


FEI Financial Reporting Blog provides highlights from SEC, PCAOB, FASB, IASB, and other regulatory news, including reporting under Sarbanes-Oxley Sect 404. It is written by Edith Orenstein, Director of Technical Policy Analysis at FEI.


Sue Anderson has 30 years of experience in continuing education for accountants. Currently she is the program director for online CPE provider CPE Link.


Jim Fahey is COO of Apple Growth Partners, a regional CPA firm in Ohio. His focus is on the effective and efficient use of technology within the firm by all team members.

Caleb Newquist is the Editor-in-Chief of Sift Media US, overseeing content for both AccountingWEB and Going Concern.

Leita Hart-Fanta, CPA, CGFM, and CGAP is the author of "The Yellow Book Interpreted" and owner of Yellowbook-CPE.com a website devoted to training for governmental auditors.


AccountingWEB is more than just a U.S. team of journalists and financial and technology experts - we have an international side, too! Members of our British team who publish AccountingWEB.co.uk share their ideas, insights, and perspectives from across the pond.