Title: RISK MANAGEMENT OVERVIEW: Five Sources of Risks and Mitigating Strategies
1RISK MANAGEMENT OVERVIEW Five Sources of Risks
and Mitigating Strategies
- by
- Dr. Jerry White
- Department of Applied Economics and Management
- Cornell University
- Ithaca, NY
Modified by Georgia Agriculture Education
Curriculum Office June, 2002
Cornell Horticultural Business Management and
Marketing Program
2All through this presentation, the focus is on
reducing variability in net income, not
increasing net income!
Stability of income, so that the grower can meet
financial obligations (both personal and
business), is the goal of risk management.
3Table 1. Receipts per acre, price per ton, and
yield per acre, Lake Erie Grape Farm Cost Survey,
(1991 2000). Low High Average
__________________________________________________
_______ Receipts per acre () 1,189 2,026 1,614 P
rice per ton () 203 338 254 Yield
(T/Ac) 4.8 8.3 6.5 ______________________
__________________________
4(No Transcript)
5Factors which affect risk tolerance
- Age
- Family status
- Debt level
- Psychological makeup
6Five sources of risk
- Production
- Marketing
- Financial
- Legal and environmental
- Human Resource Management
7Production Risks - major sources
- Weather
- - drought
- - freezes
- - excessive rainfall at harvest
- Pests
- - insect damage
- - disease damage
- - wildlife
8Tools and strategies to deal with production
risks
Enterprise diversification - grow more crops,
more varieties of grapes, get off-farm employment
for the owner (small farm) or the spouse to
diversify income sources. Crop insurance -
when used with a sound marketing program, can
stabilize income.
9Tools and strategies to deal with production
risks (continued)
Adjusted Gross Revenue Insurance (AGR)
-protects against both yield and price risk by
insuring revenue based on the average of the past
five years of revenue as determined from Schedule
F. Multiple-Peril Crop Insurance (MPCI) -
protects vs. yield shortfall by coverage against
most natural disasters.
10Tools and strategies to deal with production
risks (continued)
The combination of AGR and MPCI - Benefits and
premiums are coordinated in such a way that you
dont pay double premiums, but do not receive
double coverage, either. Subsidized premiums
and cost share such that the grower pays only
about 25 percent of the actuarial costs of the
policy.
11Tools and strategies to deal with production
risks (continued)
Catastrophic Risk Protection (CAT) coverage
-the lowest level of MPCI. Technology to
protect vs. weather events irrigation, tile
drainage, frost protection.
12Tools and strategies to deal with production
risks (continued)
- Site selection - consider rented acreage which
is less susceptible to freeze related events, or,
for new plantings, buy superior sites close to
the home base. - Timeliness of operations - insure that inputs are
applied and operations occur at the optimal time
for attaining high yield and quality fruit.
13Marketing Risks - major sources
- Price risk due to increases in supply, changed
demand - Loss of market access due to plant relocation or
closing - Loss of marketing power due to small size of farm
sellers relative to buyers, etc.
14Tools and strategies to deal with marketing risks
- Developing a marketing and/or a business plan
(White and Uva, 2000).
15Tools and strategies to deal with marketing
risks (continued)
- Form or join a marketing cooperative.
- - May enhance prices
- - Guarantees a market
- - Evens out cash flow through deferred
payments (there is a cost for deferred
payments - interest - but then most risk
management strategies have costs).
16Tools and strategies to deal with marketing
risks (continued)
- Direct Marketing - Your receipts are likely to
vary less than if you sell to processors or fresh
market wholesalers. -
17Financial Risks - major sources
- Production risks
- Price risks
- Inflation, especially cost increases of key
inputs - Increases in interest rates
18Tools and strategies to deal with financial risks
- Monitor and try to control key financial ratios
and expenses - Trend analysis (E.G. receipts, expenses, yields,
net worth) - Increase solvency - debt-to-asset ratio - pay
down debt in a good year
19Tools and strategies to deal with financial
risks (continued)
- Maintain liquidity - current ratio, or current
assets/current liabilities at 2.0 or above - Maintain credit reserves
- Invest in making the business more efficient, or
lowering cost/unit
20Tools and strategies to deal with financial
risks (continued)
- Family expenditures - There is an interaction
between family and business obligations in most
farm businesses. Defer some household
expenditures when income is low. - Off-farm employment for a spouse or other family
member-preferably in a business that is not
directly related to agriculture. Benefits such
as health insurance, group life insurance, and a
retirement program are helpful!
21Tools and strategies to deal with financial
risks (continued)
- Non-farm investments (IRAs, mutual funds) to
diversify the asset portfolio - USDA provides emergency assistance and loans or
loan guarantees through FSA
22Legal and Environmental Risks - major sources
- Tort liability (especially for direct
marketers) - Environmental liability, business structure
23Tools and strategies to deal with legal and
environmental risks
- Carry sufficient farm or business liability
insurance. - The best advice is to be forthcoming with your
insurance agent about all direct marketing
activities so that you can be assured of adequate
coverage.
24Tools and strategies to deal with legal and
environmental risks (continued)
- Use good agricultural practices
- Good neighbor relations
- Dont automatically assume that sole proprietor
is the best business organization. Consider,
e.g., LLCs or corporations
25Human Resource Management Risks - major sources
- Loss of an essential owner, manager, employee
- The three Ds
- - divorce
- - death
- - disability
26Tools and strategies to deal with human resource
management risks
- Good Human Resource management practices (for
family as well as outside employees) - Life insurance for key owners to insure business
continuity
27Tools and strategies to deal with human resource
management risks (continued)
- Formalizing planning and management can improve
business performance as well as improving safety
performance and reduce legal risk arising from
employee relationships (Maloney and Petracek). - Control liability of employees
28Points to Remember
- Business and family finances are intertwined in
most farm businesses - The focus of risk management is to reduce
variability of net income so that business and
family financed obligations can be met - Tolerance for risk is different from one farm
family to another depending on factors such as
age, family status, debt levels, and
psychological makeup.