Gartner Research

The “Risk Balance Sheet” — What It Is and Why You Need One

Published: 04 May 2023


Executive leaders can use this concept to spot whether and where they can afford to take more risk so the enterprise can grow. A look at “risk assets,” “risk debt” and “risk equity” will show where moves outside of stated tolerance levels might not cost the organization as much as it thinks.

The world is getting riskier. This is a clichéd but true statement. However, the real problem for companies is not that they face more risk — it’s that they don’t know what risks they are taking, how much risk they are taking or whether they are taking the right risks. Eighty-six percent of enterprise risk management and assurance leaders say their decisions always or sometimes lead to risk events that could have been avoided. Only 51% say they are taking on the appropriate level of risk. That lack of awareness takes a toll on opportunity, too.

Poor risk visibility helps explain why companies are unable to successfully move faster to push new products, business models or operational changes to scale. A new method that translates risks into business language can improve the business’s comfort with rolling out initiatives. Use a “risk balance sheet” to assess the portfolio of major strategic decisions and clarify where the organization can afford to take a chance.

The risk balance sheet consists of “risk assets,” “risk debt” and “risk equity” (see Figure 1 and Table 1). These three variables are the result of the organization’s decision making and its alignment to the organization’s risk tolerance. Using a familiar corporate finance frame, rather than abstract risk language (e.g., “risk appetite,” “risk capacity,” etc.), helps executives more quickly grasp the risk created (or not) by their decisions.

Figure 1: Risk Balance Sheet

A risk balance sheet provides an organizing principle for aggregating and reviewing strategic moves — decisions by senior management with the potential to affect more than 1% of EBITDA. Examples include acquisitions and divestitures, new product launches, geographical expansion into new markets, changing a main supplier, or building a major facility.

Any of these decisions may be above or below the organization’s risk tolerance. Decisions above the organization’s risk tolerance create “risk debt.” The organization accumulates liability by operating above risk tolerance for a period of time.

Conversely, a safe decision that is below risk tolerance creates a “risk asset.”

Finally, just as in a regular balance sheet, the two sides of the ledger must balance, so over time, an organization builds up “risk equity” as the difference between the two — which can be positive or negative depending on the risk profile of the decisions made.

To illustrate these concepts, let’s look at two great examples on both sides of the spectrum. Apple is a company that manages its risk balance sheet very well. It strategically accumulates a large portfolio of risk assets, then leverages the resulting risk equity sparingly and to great effect. Think of the company’s incremental launches of iPhones and iPads. Unveiling the iPhone 12 after the iPhone 11, or the iPad mini 2 after the iPad 4, illustrate risk-asset-creating strategic moves. In simple brand extensions or updates, the strategic risk is often low, and success is more likely.

After building significant risk equity in this way, Apple puts risky projects in the market that incur risk debt. Consider the Apple Watch — the most significant new product Apple has launched in the last decade. Wearable wrist devices represented a completely new category for the company, and success was far from guaranteed.

In fact, the way Apple leaders first conceived of the watch, as a piece of jewelry rather than a smart timepiece, was a failure. Very few bought the gold version of the first AppleWatch (priced for thousands of dollars). But the company had collected plenty of risk equity and could afford some new risk debt.

In late 2023, Apple is forecast to launch its first augmented reality/virtual reality headset, a riskier move that will incur significant risk debt. Technology news providers have even speculated that Apple will launch its own semiautonomous car.

Broadly, though, Apple’s leaders have made a consistent set of decisions over time that has created a portfolio of “risk assets” that gives the company the leverage it needs to incur “risk debt” if it decides to operate outside its risk tolerance for a period.

Tesla, on the other hand, seems to operate with very low risk equity. The company makes risky bets one after another, such as the Model S and the Cybertruck. Tesla has been able to incur this risk debt thanks to the track record of CEO Elon Musk’s decision making and the resulting confidence investors have bestowed upon him. That investor confidence has become an extremely strong risk asset for the company. Against that risk asset, Tesla could make its bets while running a low, or even negative, risk equity. Will Musk jeopardize that risk asset because of the controversy surrounding his actions as CEO of Twitter?

Table 2 shows some additional examples that are common across organizations.

Deliberating a significant strategic move is one of the most important use cases for a risk balance sheet. Perhaps a competitor has entered an adjacent market and the organization is deciding whether to follow suit, or senior management is considering the go-ahead for a major new product. At this time, risk leaders can bring the risk balance sheet to executives and show how this new strategic move would affect the company’s risk equity. In essence, the risk balance sheet clearly shows whether the organization has stockpiled enough risk equity to movewithout jeopardizing its resilience and sustainability.

The balance sheet also helps frame individual decisions in the context of a broader portfolio. In the example of a new competitor, if the organization needs to act to address a new strategic threat, executives must ask: “Is there a concurrent step we can take elsewhere to reduce risk debt?”

The board of directors should also study the risk balance sheet, at least annually, and assess the need for changes. Does the company want executives to rebalance the ledger? The board and senior management should also review the risk balance sheet whenever there is a significant change in the risk landscape.

In general, the more that risk can be quantified, the better. Organizations with a higher degree of risk quantification experience 2.67 times better risk management outcomes. Fully quantifying risk is hard, but do what you can.

A risk balance sheet can be used at various levels of the organization. When full quantification is not possible, we recommend a semiquantitative approach, in which each strategic move is assigned a score. The score can range from -5 to +5; -5 indicates a move is as far below risk tolerance as possible and +5 indicates it is as far above as possible.

At more tactical levels, however, a specific metric might be available, allowing executives to fully quantify a risk and compare it to the set risk tolerance (see Table 3). In each case, we are measuring the amount of risk we are taking relative to the risk tolerance (i.e., the creation of risk debt or assets).

In the “never normal” era, with a permanently higher level of risk, and with many potential uninsurable risks, organizations mustbe sure that the risks they are taking are the right ones. That’s a very different mission than taking few risks overall; cold feet could freeze your company in place while rivals speed ahead. A risk balance sheet helps the organization achieve its strategic objectives — and do so while taking the right amount of risk.

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2022 Gartner Risk Assessments in a Volatile World survey. The survey was conducted online from October through November 2022 among 300 director level and above respondents involved in performing or overseeing formal enterprise risk assessments or overseeing the enterprise risk assessment process. The respondents were from North America — U.S. and Canada; EMEA — U.K., Germany, France, Nordics; APAC — Australia, New Zealand, Singapore, India; and from $50 million + sized organizations from all industries except government and nonprofit.

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2022 Gartner Risk Assessments in a Volatile World Survey

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