Farm Business Risk Management: Understanding & Managing Risks in Agriculture, Study notes of Agricultural engineering

Download Farm Business Risk Management: Understanding & Managing Risks in Agriculture and more Study notes Agricultural engineering in PDF only on Docsity! Risk Management Study Guide 1 Risk Management The operating environment for farm business managers is changing rapidly. These changes include reduced government support for agriculture, global markets, changes in the structure of farms and agribusinesses, and changes in production and electronic technology. These changes pose major risk management challenges for operators and the urgency to develop and deliver an educational curriculum to address their needs. The major components of this curriculum are: understanding the operating environment; establishing a mission statement and goals; taking stock of your ability to handle risk; understanding and managing production, marketing, financial, legal, and human risks; and building a management team. RISK AND BUSINESS PLANNING Risk is the possibility of adversity, loss or damage. In terms of an operational plan it is also the possibility of not achieving specific goals of the operators and the business. It can impact current profit levels, the financial status of the operation or the equity position of the owners, and the satisfaction and well being of the people involved. Risk Management Risk management involves choosing among alternatives to reduce the affects of risk. It is the use of time and financial resources to effectively manage the risk so that the goals can be achieved. All occurrences which can be classified as risks, affect outcomes but there are differences in the degree of the impacts or the potential severity. Significant time and money can be spent to avert a risk but the net benefit may not be positive. Accordingly, it is appropriate to focus on both the time and financial resources needed to manage the risk and to balance this allocation with the goals being pursued. The other reason to put risk management in this context is that risks and rewards are correlated. Entrepreneurial returns will not be realized without taking risks. The operator must evaluate the potential gains in relation to the potential loss. Lastly, farmers have different risk tolerances both from the point of view of their financial situation and their personal tolerances. The Risk Management Process Risk management is a process that includes these steps: (1) identifying or listing the relevant risks, (2) assessing the magnitude of these potentially risky events, (3) measuring the likelihood of the event occurring, (4) specifying the actions that can be taken, and (5) implementing a plan. Risk management becomes an individualized process as there are many combinations of alternatives that could fit with an individual's ability and willingness to bear risk. The process is built on the foundation of the mission and goals of the family and business operators. 1. The identification of the relevant risks can be achieved by using a set of checklist questions such as "what could adversely effect my cash flow?", "is my marketing plan consistent with my financial plan?", "what risks do contractual arrangements pose?". The five major areas of risk are production risk, marketing risk, financial risk, legal risk and human resources risk. A series of questions related to each of these five major areas of risk can be drawn up to identify the critical risks for a particular operation (Baquet, Hambleton and Jose, 1997). 2. The magnitude of a risk should measure the income and equity impacts. The measurements should have enough quantification to be able to compare risks and establish priorities and to be able to determine the time and financial commitments to alleviate the risks. The outcome should be more than a qualitative measurement or a simple comparison of the severity of the risks. Often, measuring the likelihood or Risk Management Study Guide 2 probability of the occurrence typically follows the identification of a specific risk. However, producers typically have more information available on the potential impact of a particular risk than it's probability or likelihood. This is based on their experiences and observations and the difficulties in collecting a frequency data set. Consequently, measuring the magnitude before the likelihood is a more logical, applicable sequence for producers than vice versa. 3. The likelihood can be more comparative than the magnitude and still provide the information the decision maker needs. For example, one outcome is twice or three times as likely as another outcome. Risk ultimately must be quantified to evaluate various risk management tools and strategies. It is a process of assessing the randomness of future events based on logic and experience (Harwood et al 1999). 4. There are three basic categories of actions to deal with risk. These are reducing the odds or chances of an adverse event, transfer the risk, and mitigate the risk. The odds of an adverse outcome can be reduced with such actions as variety selection, dispersing production geographically, hedging strategies, and machinery maintenance. The risk can be transferred through formal insurance and forward contracting. The risk can be mitigated with actions which reduce the impact if the adverse outcome actually does occur. Examples of actions to provide protection include holding cash reserves, diversifying enterprises, limiting credit and leverage, and spreading sales. 5. Implementing a plan may be the major constraint in effective risk management. It requires confidence in the information available and the ability to assess the alternative strategies. A format to go through the process is presented in Table 1. The first section is designed to identify the major risks in the five risk areas of roduction, marketing, financial, legal and human resources and to evaluate the relative importance associated with each by attaching a high, medium or low priority to each. The second section is designed to take the high priority items from the first part and evaluate the magnitude, likelihood of the risk, the possible actions that can be taken and the cost and time feasibility of the actions. SUMMARY A successful risk management plan increases the value of the business because it increases the chances that the business will not only survive but also prosper. For example, effective risk management could result in more favorable lending terms. An effective transition and estate plan will facilitate the successful transfer of the business from one generation to the next. An effective risk management plan positions the operation for the future by managing the impacts that a variety of risks might have on the business, opening up the opportunity to consider new and innovative alternatives. H. Douglas Jose University of Nebraska, Lincoln, Nebraska, USA