As you think about managing risk to stabilize farm income, there are five basic sources of agricultural risk that you should address: Production, marketing, financial, legal, and human resource risks. Various tools and strategies can be used to manage each of these risks.
1) Production Risks
Production risks relate to the possibility that your yield or output levels will be lower than projected. Major sources of production risks arise from adverse weather conditions such as drought, freezes, or excessive rainfall at harvest or planting. Production risks may also result from damage due to insect pests and disease despite control measures employed, and from failure of equipment and machinery such as an irrigation pump.
Strategies to manage production risks include:
- Follow recommended production practices.
- Diversify enterprises by growing different crop varieties and completely new crops.
- Expand production through more intensive growing practices or by planting more acreage.
- Purchase federal crop insurance coverage to stabilize income during times of loss and purchase NAP coverage for noninsured crops.
- Adopt risk mitigating practices such as drip irrigation, tile drainage, trap crops or resistant varieties.
- Consider site selection - use fields less susceptible to frost or pests and rotate crops.
- Maintain equipment and keep facilities in good working condition.
2) Marketing Risks
Marketing risks relate to the possibility that you will lose the market for your products or that the price received will be less than expected. Lower sales and prices due to increased numbers of competing growers or changing consumer preferences are common sources of marketing risk. Marketing risks can also arise from loss of market access due to a wholesale buyer or processor relocating or closing, or if a product fails to meet market standards or packaging requirements.
Strategies to manage marketing risks include:
- Develop a marketing plan with realistic sales forecasts and target prices.
- Form or join a marketing cooperative to enhance prices and guarantee a market.
- Increase direct marketing efforts to capture a higher price.
- Market through multiple channels or outlets to reduce reliance on a single market.
- Enter into sales or price contracts with buyers.
- Spread harvest and sales over the season by scheduling planting and considering storage.
- Conduct essential market research - understand your customers’ needs and preferences.
- Purchase Whole-Farm Revenue Protection to cover unexpected decline of market prices during the growing year.
3) Financial Risks
Financial risks relate to not having sufficient cash to meet expected obligations, generating lower than expected profits, and losing equity in the farm. Sources of financial risk commonly result from production and marketing risks described earlier. In addition, financial risks may also be caused by increased input costs, higher interest rates, excessive borrowing, higher cash demand for family needs, lack of adequate cash or credit reserves, and unfavorable changes in exchange rates.
Strategies to manage financial risks include:
- Develop a strategic business plan.
- Monitor financial ratios and enterprise benchmarks.
- Control key farm expenses - consider other suppliers and alternative inputs.
- Conduct a trend analysis to assess change in farm profits and owner’s equity over time.
- Consider purchasing Whole-Farm Revenue Protection to provide a safety net in poor earning years.
- Communicate and renegotiate agreements with suppliers and loan terms with lenders.
- Consider leasing and rental options rather than purchasing machinery, equipment or land.
- Evaluate the possibility of expanding or contracting different enterprises.
- Control or defer unnecessary family and household expenditures.
- Find off-farm employment for a family member, preferably a job with benefits such health insurance, group life insurance, and a retirement program.
- Use non-farm investments such as IRAs or mutual funds to diversify your asset portfolio.
4) Legal and Environmental Risks
In part, legal risks relate to fulfilling business agreements and contracts. Failure to meet these agreements often carry a high cost. Another major source of legal risk is tort liability - causing injury to another person or property due to negligence. Lastly, legal risk is closely related to environmental liability and concerns about water quality, erosion and pesticide use.
Strategies to manage legal risks include:
- Review business insurance policies and carry sufficient liability coverage.
- Choose a different business legal structure – as an example, a sole proprietorship is not always best.
- Understand business contracts and agreements - ask questions if you are unsure.
- Develop good relationships with neighbors and address their concerns.
- Use good agricultural practices to limit environmental risk.
- Know and follow state and federal regulations related to your farming operation.
5) Human Resource Management Risks
Human resource risks pertain to risks associated with individuals and their relationships to each other. These relationships include those with family members, as well as farm employees and customers. Key sources of human resource risk arise from one of the “three D’s” — divorce, death, or disability. The impact of any of these events can be devastating to a farm. Human resource risks also include the negative impacts arising from a lack of people management skills and poor communications.
Strategies to manage human resource risks:
- Develop and practice good “people skills” with family members, as well as employees.
- Evaluate alternative sources of labor.
- Provide adequate training for employees - formalized programs may help your safety record and improve performance.
- Communicate with employees and family members.
- Recognize and reward good performance.
- Review wills, trusts, and powers of attorney.
- Initiate estate transfer and business succession planning.
- Consider health and life insurance needs.
Managing risk starts with identifying the most crucial risks you face; understanding the potential impacts and likelihood of undesirable outcomes; and, identifying and taking possible steps to mitigate or lessen the impacts. It’s unlikely any one person understands all the areas of risk faced by a family farm. If you don’t know the answer or find it difficult to initiate risk management planning on your own, get assistance from Cooperative Extension, USDA, attorneys, bankers, insurance agents, and other service providers.
Written by Michael Sciabarrasi, Extension Professor (Retired), Agricultural Business Management, UNH Cooperative Extension.