RISK MANAGEMENT OVERVIEW:

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Nov 20, 2013 (3 years and 6 months ago)

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Cornell Horticultural Business Management and Marketing Program

Cornell Horticultural Business Management and Marketing Program

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

Stability of income,
so that the grower
can meet financial obligations (both
personal and business),
is the goal of
risk management
.

All through this presentation, the focus is
on reducing variability in net income,
not increasing net income!

Cornell Horticultural Business Management and Marketing Program

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


Price per ton ($)


203


338


254


Yield (T/Ac)


4.8


8.3


6.5

________________________________________________

Cornell Horticultural Business Management and Marketing Program

LEGFCS Gross Income per Acre
0
500
1000
1500
2000
2500
3000
3500
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
est.
$ per acre
High
Average
Low
Cornell Horticultural Business Management and Marketing Program

Real Life Results From Two Co-operative Farms, Even With "Smoothing" of
Income Stream From Co-operative Payment Schedules
0
500
1000
1500
2000
2500
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
$ per acre
Farm A (CV = .22)
Farm B (CV = .18)
LEGFCS Ave. (CV = .13)
Cornell Horticultural Business Management and Marketing Program

Factors which affect risk tolerance


Age


Family status


Debt level


Psychological makeup

Cornell Horticultural Business Management and Marketing Program

Five sources of risk


Production


Marketing


Financial


Legal and environmental


Human Resource Management

Cornell Horticultural Business Management and Marketing Program

Production Risks

-

major sources:


Weather



-

drought



-

freezes



-

excessive rainfall at harvest



Pests



-

insect damage



-

disease damage



-

wildlife


Cornell Horticultural Business Management and Marketing Program

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.


Cornell Horticultural Business Management and Marketing Program


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
.


Tools and strategies to deal with
production risks:
(continued)

Cornell Horticultural Business Management and Marketing Program



The combination of AGR and MPCI
-

Benefits and
premiums are coordinated in such a way that you
don’t 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.

Tools and strategies to deal with
production risks:
(continued)

Cornell Horticultural Business Management and Marketing Program



Catastrophic Risk Protection (CAT) coverage
-
the lowest level of MPCI.




Technology

to protect vs. weather events:
irrigation, tile drainage, frost protection.


Tools and strategies to deal with
production risks:
(continued)

Cornell Horticultural Business Management and Marketing Program



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.


Tools and strategies to deal with
production risks:
(continued)

Cornell Horticultural Business Management and Marketing Program

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.

Cornell Horticultural Business Management and Marketing Program

Tools and strategies to deal with
marketing risks:


Developing a
marketing
and/or a business plan

(White
and Uva, 2000).


Futures and Options

Cornell Horticultural Business Management and Marketing Program

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).

Cornell Horticultural Business Management and Marketing Program

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.





Cornell Horticultural Business Management and Marketing Program

Financial Risks

-

major sources:


Production risks


Price risks


Inflation, especially cost increases
of key inputs


Increases in interest rates


Cornell Horticultural Business Management and Marketing Program

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”

Cornell Horticultural Business Management and Marketing Program

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

Cornell Horticultural Business Management and Marketing Program

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!

Cornell Horticultural Business Management and Marketing Program

Tools and strategies to deal with
financial risks:
(continued)


Non
-
farm investments
(IRA’s, mutual
funds) to diversify the asset portfolio



USDA provides emergency assistance
and loans or loan guarantees through
FSA

Cornell Horticultural Business Management and Marketing Program

Legal and Environmental Risks

-

major sources:


Tort liability (especially for direct

marketers)



Environmental liability, business
structure




Cornell Horticultural Business Management and Marketing Program

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.

Cornell Horticultural Business Management and Marketing Program

Tools and strategies to deal with legal
and environmental risks:

(continued)


Use “good agricultural practices”



Good neighbor relations



Don’t automatically assume that sole
proprietor is the best business
organization. Consider, e.g., LLC’s or
corporations

Cornell Horticultural Business Management and Marketing Program

Human Resource Management
Risks

-

major sources:


Loss of an essential owner,
manager, employee





The three D’s



-

divorce



-

death



-

disability

Cornell Horticultural Business Management and Marketing Program

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

Cornell Horticultural Business Management and Marketing Program

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

Cornell Horticultural Business Management and Marketing Program

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.