The 1st step in the process of managing risk is identifying and classifying the potential risks. The five key sources of risk are: Production, Marketing, Financial, Legal and Human.
The major sources of production risks are weather, climate changes, pests, diseases, technology, genetics, machinery efficiency, and the quality of inputs.
Agricultural production indicates an expected outcome or yield. Changeability in those outcomes poses risks to your ability to attain financial goals. Any production related activity or event that has a range of possible outcomes is a production risk. The main sources of production risks are weather, climate changes, technology, pests, diseases, machinery efficiency, genetics, and the quality of inputs. Fire, theft, wind, and other casualties are also causes of production risk.
Marketing is that part of a farm business that converts production activities into financial success. Agriculture operates in universal market. Unexpected forces anywhere in the world, such as weather or government action, can lead to dramatic changes in output and input prices. When these forces are understood, they can become significant considerations for the skilled marketer. Marketing risk is any market related activity or event that leads to the variability of prices farmers receive for their products or pay for production inputs. Access to markets is also a marketing risk.
Financial risk includes those risks that threaten the financial health of the business and has 4 basic components:
1) The cost and availability of capital;
2) The ability to maintain and grow equity;
3) The ability to meet cash flow needs in a timely manner;
4) The ability to absorb short-term financial shocks.
Cash flows are especially important because of the variety of on-going obligations such as cash input costs, cash lease payments, tax payments, debt repayment, and family living expenses.
Many of the everyday activities of all farmers involve promises that have legal implications. Understanding these issues can lead to better risk management decisions. Legal issues intersect with other risk areas. For example, acquiring an operating loan has legal implications if not repaid in the specified manner. Production activities including the use of pesticides have legal implications if appropriate safety precautions are not taken. Marketing of agricultural products can involve contract law. Human issues related with agriculture also have legal implications, ranging from employer/employee rules and regulations, to inheritance laws. The legal issues commonly associated with agriculture fall into five broad categories:
1) Contractual arrangements;
2) Laws and regulations;
3) Business organization;
4) Tort liability; and,
5) Public policy and attitudes.
People are equally a source of business risk and an important part of the strategy for dealing with risk. At its core, human risk management is the skill to keep all people who are involved in the business safe, satisfied and productive. Human risk can be summarized into four main categories:
1) Family and business relationships;
2) Human health and well-being;
3) Employee management; and,
4) Transition planning.
Probabilities are only a way of expressing the chance of various outcomes occurring. Weather forecasts use probabilities. For example, they might indicate a 20 percent chance of rain or a 40 percent chance of snow. Some probabilities are recognized objectively by observation or measurement. Some probabilities must be subjectively estimated by the decision maker.
Variability of outcomes is usually associated with risk, and riskier situations naturally have greater variability of outcomes. The average outcome is the most frequent or most likely if outcomes are normally distributed, but the average does not provide information about variability. The range, the highest and lowest possible values, combined with the average does provide some information about variability. However, it is difficult to make comparisons of variability between agricultural enterprises or prices.
The probabilities of outcomes translate into the financial impact of those numerous possible outcomes. For example, the probability of a specific crop yield will result in a specific net income. Measuring risks includes an assessment of the probabilities of the possible outcomes and the impact of each outcome.
Assess Risk Bearing Capacity
Risk management strategies are also affected by an individual’s capacity or ability to bear (or to take) risk. Financially, risk bearing capacity is directly related to the solvency and liquidity of one’s financial position.
Risk bearing ability is also affected by cash flow requirements. This contains the obligations for cash costs, loan repayment, taxes, and family living expenses that must be met each year. The higher these obligations are as a percentage of total cash flow, the less able the business is to assume risk. The best source of historical production and marketing information is the records maintained for the business. The records may be supplemented and complemented by information from outside sources. But there is no substitute for actual historical data.
Evaluate Risk Tolerance or Preferences
People may be characterized into one of three broad categories of risk tolerance. Risk averse producers are the most cautious risk takers. They are willing to give up some income to some level of avoid risk. They may value safety, stability, or financial survival more than an opportunity for higher profits.
Risk neutral producers understand they must take some chances to get ahead, but identify that there are degrees of risk in every situation. Before deciding or acting, they gather information and analyse the odds and seek to maximize income.
Risk preferring individuals enjoy risk as challenging and exciting and look for the chance to take risks. Some producers may be in this category with respect to their marketing plans, even though they may not consciously plan to take on market risk. They may enjoy the adventure of playing the market. Pure speculators are typically in this category.
Set Risk Management Goals
A meaningful goal is specific, attainable, measurable, challenging but realistic, written, time specific, and performance based. If one achieves all conditions of a specific measurable goal, confidence increases and satisfaction results. If a measurable goal is not achieved, objective analysis can occur and adjustments can be made to improve the likelihood of success.
Care should be taken to set goals over areas where one has as much control as possible. Nothing is as discouraging and counterproductive to goal setting as failing to achieve a goal for reasons beyond your control. If goals are set on performance or skills to be acquired, then control over achievement is maintained.
There are beneficial reasons to set goals:
1) To provide a basis for all business and family decisions;
2) To reflect the values, interests, resources and capabilities of everyone involved in the business;
3) To set priorities for the allocation of scarce resources; and,
4) To measure progress.
Identify Effective Risk Management Tools
Because of the many sources of risk, comprehensive strategies that integrate numerous responses to variability are often essential for effective risk management. The combination used by an individual farmer will depend on the individual’s situation, the categories of risk faced, and the risk attitudes or preferences. Some risk responses such as vaccinations, feed inventories, preventative maintenance, and irrigation act primarily to reduce the chance that an adverse event such as disease, breakdown, and drought will occur. Other responses have the effect of providing protection against adverse consequences by transferring some of the risk to someone else such as insurance and forward pricing. Producers find many ways to implement these principal risk responses. Tools are discussed for each of the five areas of risk later in this manual.
Select Professional Assistance
Even though risk management is challenging, there are several professional resources available and farmers should not feel isolated. Extension educators and university extension specialists are trained to provide educational programs and leadership to help implement the planning process. Insurance agents, crop and livestock consultants, livestock nutritionists, marketing specialists, lenders, attorneys and others are available and well qualified to help with risk management planning, depending upon the specific need.
Many of these professionals have a stake in the farm business and have an incentive to provide objective information and feedback on alternative strategies. The regular use of a business advisory team keeps the business fine-tuned and on the cutting edge. Be judicious in selecting professional help. Ask for references and credentials as appropriate. Rely on the experience of other growers, input suppliers, implement dealers, peer groups, allied professionals, trade association recommendations, and trusted friends and mentors.
Decide and Implement the Plan
Maybe the most difficult aspect of any decision process is implementing the plan. Following through the steps provides the confidence and numerical measurements to implement a plan that best fits the situation.
Evaluate the Results
Include a mechanism to gather the results of the plan, compare with the expected outcomes and make plans for adjustments, if necessary, for future decision cycles.
Overall risk management plan checklist
Have the risk outcomes and their likelihood or probability of occurring been estimated?
Have the primary sources of risk been identified and classified?
Has the financial capacity of the business or ability to bear risk been evaluated?
Are risk goals written and are they specific, measurable, attainable, relevant, and timed?
Have the goals been shared with everyone involved in the business?
Have the risk tolerances of the business operators been considered?
Have risk tools and strategies been identified to help manage risks which could prevent achieving established goals?
Has a confident relationship been established with a team of risk management advisors, so they can help assess and manage business and personal risk exposure?
December 04, 2017