RISK MANAGEMENT OVERVIEW: Five Sources of Risks and Mitigating Strategies

1
RISK 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
2
All 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.
3
Table 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)
5
Factors which affect risk tolerance

• Age
• Family status
• Debt level
• Psychological makeup

6
Five sources of risk

• Production
• Marketing
• Financial
• Legal and environmental
• Human Resource Management

7
Production Risks - major sources

• Weather
• - drought
• - freezes
• - excessive rainfall at harvest
• Pests
• - insect damage
• - disease damage
• - wildlife

8
Tools 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.
9
Tools 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.
10
Tools 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.
11
Tools 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.
12
Tools 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.

13
Marketing 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.

14
Tools and strategies to deal with marketing risks

• Developing a marketing and/or a business plan
  (White and Uva, 2000).

15
Tools 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).

16
Tools 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.

17
Financial Risks - major sources

• Production risks
• Price risks
• Inflation, especially cost increases of key
  inputs
• Increases in interest rates

18
Tools 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

19
Tools 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

20
Tools 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!

21
Tools 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

22
Legal and Environmental Risks - major sources

• Tort liability (especially for direct
  marketers)
• Environmental liability, business structure

23
Tools 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.

24
Tools 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

25
Human Resource Management Risks - major sources

• Loss of an essential owner, manager, employee
• The three Ds
• - divorce
• - death
• - disability

26
Tools 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

27
Tools 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

28
Points 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.