Current Progressive Dairy digital edition
Advertisement

1309 PD: Looking at risk management

Rob Holcomb Published on 25 August 2009

The topic of risk management conjures up a wide array of understanding among agricultural producers.

Although textbooks are fairly uniform in the definition of risk management and the components thereof, this overall topic is not well understood.Most discussions on risk management include five general areas. These include production risk, marketing risk, financial risk, legal risk, human risk.

Many authors agree that risk is part of any business venture. To effectively manage risk, in most cases, does not remove the risk, but rather shifts the risk to another party or entity.

advertisement

advertisement

Production risk is the component of risk management that farm managers understand very well. Production risk, as the name indicates, is the risk associated with production. The most common tool available to the farm manager is a variety of crop insurance products that will insure yield or revenue for a given crop. The portion of crop insurance that protects against yield loss relates to production risk. The portion of crop insurance that protects or insures revenue falls under the category of marketing risk.

Production risk also includes securing and maintaining a land base which involves landlord/tenant arrangements (if you lease any of your land). Selection of suitable seed genetics addresses not only production yield, but drydown and resistance to crop pests and diseases.

Marketing risk is the portion of risk management that deals with obtaining a suitable price for the produced commodity. As mentioned in the previous section, crop insurance that protects or insures revenue falls under the category of marketing risk. Components of the farm bill, such as loan deficiency payments and commodity marketing loans, help the farmer manage in times of low prices.

Producers have a new option under the 2008 farm bill, called Average Crop Revenue Election (ACRE). Producers need to carefully examine the components of ACRE and determine whether they will enroll in ACRE or stay with the more traditional DCP program.

The goal of a producer should not be to hit the top of the market. A good starting point is for the producer to know the cost of production. That way the producer is capable of locking in a profit when a marketing opportunity presents itself.

advertisement

The producer should have a complete understanding of the various marketing tools available for setting a price for his or her commodities (cash markets, forward contracting, hedging with futures, etc.).

Financial risk includes the areas of strategic planning, business planning, credit analysis and farm accounting.

A good set of financial reports, including a balance sheet, income statement, cash flow projection, ratio analysis and trend analysis, are critical parts of a farm business analysis. One single component of the analysis does not tell a complete story, but rather a compilation of all the components together, including trends of the business, quickly show the strengths and weaknesses. The components of the business analysis not only provide valuable information for the farm manager, but also provide critical and required information to the farm lender.

Legal risk is assumed every day. This can take the form of legal issues, such as land lease agreements, grain sales or any major transactions. Grain sales are often conducted over the phone with no paperwork to back them up. Producers, in order to avoid future misunderstandings, should have formal agreements reviewed by legal counsel. Insurance coverage, especially liability coverage, should be reviewed regularly.

Human risk involves the "people factor" in the farming operation. Death, divorce, injury, illness of a principal owner, manager or employee of a farm can disrupt how the farm performs or even survives. Succession planning as part of a business plan can help in case of death, illness or injury. Proper labor management, including hiring the right people, can lead to business success, while improper labor management can be extremely costly to the farming operation.

By utilizing available risk management tools, farm managers are able to make more informed and profitable decisions. PD

advertisement

References omitted but are available upon request at

--Excerpts from agbuzz.com, January 2009

Rob Holcomb
Extension Educator
Ag Business Management
University of Minnesota[

LATEST BLOG

LATEST NEWS