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The Big Five: Types of Agricultural Risk

The Big Five: Types of Agricultural Risk

As you think about managing risk to stabilize farm income, there are five basic sources of agricultural risk that you should consider – production, marketing, financial, legal, and human resource management risks. There are different tools and strategies you can use to manage each of these risks.

1) Production Risks

Production risks relate to the possibility that your yield or output levels will be lower than anticipated.  Major sources of production risks arise from inclement weather conditions (such as drought, freezes, or excessive rainfall at harvest), but may also result from damage due to insect pests and disease.

Tools and strategies:

  • Follow recommended production practices.
  • Diversify enterprises by growing different crops and varieties.
  • Expand production or plant excess acreage.
  • Purchase multi-peril crop insurance coverage to stabilize income.
  • Adopt appropriate technology such as drip irrigation, tile drainage, or resistant varieties.
  • Consider site selection – use or rent acreage less susceptible to specific pests or frost.
  •  Maintain equipment and keep facilities in good working condition.

2) Marketing/Price Risks

Marketing risks relate to the possibility that you will lose the market for your products or that the price received will be less than expected. Common sources of marketing risk include lower prices due to increased supply or decreased consumer demand; loss of market access due to the relocation or closing of a processor or other buyer; and, lack of marketing power due to the small size of farm sellers relative to others in the market.

Tools and Strategies:

  • Develop a marketing plan with realistic sales forecasts and target prices.
  • Form or join a marketing cooperative to enhance prices and guarantee a market.
  • Increase direct marketing efforts to capture a higher price.
  • Market through multiple channels or outlets to reduce reliance on a single market.
  • Enter into sales or price contracts with buyers.
  • Spread harvest and sales over the season by scheduling planting and considering storage options.
  • Conduct basic market research – survey your customers.

3) Financial Risks

Financial risks relate to the possibility of having insufficient cash to meet expected obligations, lower than expected profits, and loss of net worth.  Sources of financial risk commonly result from the production and marketing risks described earlier. In addition financial risks may also be caused by increases in key input costs, increases in interest rates, excessive borrowing, lack of adequate cash or credit reserves, and changes in exchange rates.

Tools and Strategies:

  • Develop a comprehensive business plan identifying mission, objectives and goals.
  • Monitor financial ratios and benchmarks related to liquidity, solvency and profitability.
  • Control key farm expenses.
  • Conduct a trend analysis to assess what’s happening with farm income and net worth over time.
  • Purchase whole farm revenue insurance, such as AGR or AGR-Lite, to provide a safety net.
  • Communicate with suppliers and lenders to review and renegotiate exiting contracts and loan terms.
  • Consider leasing and rental options rather than purchasing machinery, equipment or land.
  • Evaluate the possibility of business expansion (getting larger) or contraction (reducing size).
  • Control or defer unnecessary family and household expenditures.
  • Find off-farm employment for a family member, preferably a job with benefits such health insurance, group life insurance, and a retirement program.
  • Use non-farm investments such as IRAs or mutual funds to diversify your asset portfolio.

4) Legal and environmental risks

In part, legal risks relate to fulfilling business agreements and contracts. Another major source of legal risk is tort liability, i.e., causing injury to another person or property due to negligence.  Legal risk is also related to environmental liability and concerns about water quality, erosion and pesticide use.

Tools and strategies:

  • Review business insurance policies and be certain to carry sufficient liability coverage.
  • Evaluate your choice of business legal structure; a sole proprietorship is not always the best business organization.
  • Understand business contracts and agreements; ask questions if you are unsure.
  • Take time to develop good relationships with neighbors and address their concerns.
  • Use good agricultural practices to limit environmental risk.
  • Know and follow State and Federal regulations related to your farming operation.

5) Human resource management risks:

Human resource risks pertain to risks associated with individuals and their relationships to each other, their families and the farm business. Sources of human resource risk include the three D’s — divorce, death, or disability of a business owner, manager, employee or family member. It also includes risks arising from poor communications and people-management practices.

Tools and strategies:

  • Develop and practice good “people skills” for family as well as employees.
  • Evaluate alternative sources of labor.
  • Provide adequate training for employees, formalized programs may help your safety record as well as improve performance.
  • Communicate with employees and family members.
  • Recognize and reward good performance.
  • Review estate and business transfer plans to help insure the farm continues.
  • Consider long-term care and life insurance needs.

Managing risk starts with identifying the most crucial risks you face; understanding the potential impacts and likelihood of undesirable outcomes; and, identifying and taking possible steps to mitigate or lessen the impacts.  It’s unlikely any one person understands all the areas of risk a family farm faces. If you don’t know the answer or find it difficult to initiate risk management planning on your own, get assistance.

(Source – https://nevegetable.org/big-five-types-agricultural-risk)

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