Cornell Horticultural Business Management and Marketing ProgramCornell Horticultural Business Management and Marketing Program

RISK MANAGEMENT OVERVIEW:RISK MANAGEMENT OVERVIEW:

Five Sources of Risks and Mitigating Five Sources of Risks and Mitigating StrategiesStrategies

byDr. Jerry White

Department of Applied Economics and Management

Cornell UniversityIthaca, 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 2001est.

$ p

er

acr

e 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

$ p

er

acr

e

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.