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RISK MANAGEMENT OVERVIEW: Five Sources of Risks and Mitigating Strategies

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RISK MANAGEMENT OVERVIEW: Five Sources of Risks and Mitigating Strategies by Dr. Jerry White ... Cornell Horticultural Business Management and Marketing Program ... – PowerPoint PPT presentation

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Title: 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

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
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5
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6
Factors which affect risk tolerance
  • Age
  • Family status
  • Debt level
  • Psychological makeup

7
Five sources of risk
  • Production
  • Marketing
  • Financial
  • Legal and environmental
  • Human Resource Management

8
Production Risks - major sources
  • Weather
  • - drought
  • - freezes
  • - excessive rainfall at harvest
  • Pests
  • - insect damage
  • - disease damage
  • - wildlife

9
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.
10
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.
11
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.
12
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.
13
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.

14
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.

15
Tools and strategies to deal with marketing risks
  • Developing a marketing and/or a business plan
    (White and Uva, 2000).
  • Futures and Options

16
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).

17
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.

18
Financial Risks - major sources
  • Production risks
  • Price risks
  • Inflation, especially cost increases of key
    inputs
  • Increases in interest rates

19
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

20
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

21
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!

22
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

23
Legal and Environmental Risks - major sources
  • Tort liability (especially for direct
    marketers)
  • Environmental liability, business structure

24
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.

25
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

26
Human Resource Management Risks - major sources
  • Loss of an essential owner, manager, employee
  • The three Ds
  • - divorce
  • - death
  • - disability

27
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

28
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

29
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.
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