What distinguishes inherent risk from residual risk?

Inherent risk refers to the level of risk that exists in the absence of any internal controls. It represents the natural level of risk associated with an activity or process due to factors such as complexity, environment, or external situations. This type of risk is an essential consideration in risk management because it helps organizations understand the baseline levels of risk they face before implementing any mitigating measures.

When determining inherent risk, one assesses how likely it is for an undesirable event to occur and the impact it might have, should that event occur, without accounting for any risk management strategies, controls, or mitigations that could be in place.

In contrast, residual risk is the amount of risk that remains after controls and mitigation efforts have been applied. It is the remaining risk that must be managed even after steps have been taken to reduce inherent risk.

Recognizing the difference between these two concepts is crucial in risk management frameworks, especially in assessing the effectiveness of existing controls and understanding where additional measures may be needed.