The following information is bonus material from Top Producer. It corresponds with the article "Risk Audit” by Linda Smith. You can find the article in the September 2009 issue.
USDA's Risk Management Agency defines five primary sources of risk for farm businesses: production, marketing, finance, legal and human resources. Here's USDA's list of risk categories:
No one needs to tell a farmer about the negative outcomes of poor weather, pests or diseases. However, technology, machinery efficiency and the quality of inputs also play a role in production.
The following are management practices or products that can help mitigate production risks.
- Enterprise diversification (not only reduces weather risk, but price risk)
- Geographical diversification
- Crop insurance
- Contract production (the buyer supplies inputs and expertise)
- Genetic choices
- New technologies such as precision farming; vaccines
- Hire experts such as crop scouts or veterinarians
- Buy from reputable sources
- Be sure machinery and labor are sufficient to do field work in a timely manner
Purchasing / sales risks.
The past two years have brought price risk to the forefront. Another sales risk has reared its ugly head—counterparty risk (of buyer going out of business or deciding not to fulfill your contract). "Counterparty risk falls in the category of low probability but high consequences—and it likely is noninsurable,” says Boehlje. "The VeraSun bankruptcy is a perfect example where producers delivered on grain contracts but were not paid, basically becoming the company's bankers, but without the recourse a bank might have. Alternatively, in the case of Pilgrim's Pride, producers built chicken buildings only to be told plants were closing and their production would not be needed in the future.”
Here are a few steps to reducing these risks and attaining a better outcome.
- Spread sales over the marketing year
- Develop a marketing plan
- Add to your sales and risk-management strategy toolbox
- Hire a marketing service if necessary
- Consider revenue insurance
- Consider contract production
- Be careful about prepaying for inputs
- Be careful about deferred pricing on sales
- Sell to more than one buyer (and/or buy from more than one supplier)
According to USDA's Risk Management Agency, financial risk has three basic components: the ability to meet cash-flow needs in a timely manner; the cost and availability of debt capital; and the ability to maintain and grow equity. The keys to success in this arena are sound planning and financial control.
Here are some components to help you in those endeavors:
- Make sure your financial records are detailed enough and keep them up to date. Today, more farmers are moving to enterprise accounting to help them assess profitability
- Interest rate risk. By keeping your credit rating high and debt-to-asset ratio low, you may be able to capture a lower rate
- Liquidity/cash flow. Plan the timing of expenses and income
- Insurance to protect income--including life, disability, health, etc.
- Understand all legal documents before you sign—consult an attorney if you need to.
- Pay attention to family living costs and include them in cash-flow projections.
This area may not be as obvious as some of the earlier ones. There are business risks such as contracts that are pretty straightforward, but there are also risks such as choosing the wrong business form (partnership, corporation, etc.), not having a good exit plan, or lack of estate planning that can bring down a business in short order.
Some steps to take include:
- Consult a lawyer or university source about business structure, estate planning, etc.
- Make sure you understand laws regarding employees, environmental liability, and damage caused by spraying or other ag practices
- Be aware of potential liability issues that may arise regarding accidents on your property
Human resources issues.
Human resource calamities can hamper even the most carefully made and appropriate risk-management decisions. Such calamities include divorce, chronic illness and accidental death.
- Engage family and employees by involving them in the decision-making process
- Train more than one person for every job
- Prepare successors
- Insure key personnel for injury as well as death
- Make a will and other documents to spell out what will happen to the business
- Review business and ownership structures to assess the effects of divorce
- Be careful in hiring immigrants to be sure you are acting legally
Two Books that Provide More Food for Thought About Risk
Risk Intelligence: Learning to manage what we don't know, by David Apgar. "Risk management can be a source of competitive advantage long term,” says Mike Boehlje, Purdue University ag economist.
The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb. "I would encourage people to read this book and start the long process of understanding how they might deal with the Black Swan events Taleb defines as ‘a highly improbable event with three characteristics: it is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random and more predictable than it was,' ” says Steve Hofing, Centric Consulting Group (217-352-1190).