Managing Risk in Agriculture
20 July 2017
In an ever changing environment, farmers are making risky
decisions every day. A lot of the times
the consequences of those decisions are unknown and the outcomes could be good
or bad. Flexibility of prices and yields
are major sources of risk in agriculture.
Other contributors to the risky environment for farmers can be changes
in technology, legal and social concerns.
Typically, farmers and other businesses try to avoid risky situations unless there is a strong probability of making money. However, where there are higher profits there are usually higher risks. In an article by George F. Patrick of Purdue University he discusses ways to help farmers develop their own integrated risk management strategies.
Patrick advises that you set farm family goals and consider risk attitude and types of individuals, risk bearing ability, and the formulation of expectations.
Setting goals requires some time and thought. Most people have family, business, and personal goals. Our goals are not independent of other people and their goals and they are a major part of our guidance system. Individuals may have unrealistic goals which, if not revised, may be a source of frustration and stress.
There has been argument on what is the definition of the word risk. Some dictionaries say risk is the possibility of injury, damage or loss. Economists argue it means uncertainty. They decided that the lack of knowledge about the future is what’s important in both risk and uncertainty. Jerry Robinson, Jr., professor of sociology and rural sociology at the University of Illinois, lists individuals in the following risk-taking categories: avoiders, daredevils, adventurers, and calculators.
Avoiders are the most cautious risk takers but they do take some risks. They expect the worst to happen. They lose because they miss out on economic opportunities to profit. Farmers who are avoiders may not be forced out of business, but they manage to survive. Daredevils are the opposite of avoiders and take many unnecessary chances. They are the plungers who close their eyes to risk, ignore facts, and go with it. They also fail because they refuse to take precautions. They don’t get involved in farming. Adventurers enjoy risks. Risks are challenging and exciting to the adventurer. They look to take risks. Many farmers are adventurers with respect to their marketing plans. Finally, are the Calculators; they take chances to get ahead, but recognize that there are degrees of risk. Before taking that risk the calculators gather and analyze all of the information and analyze the odds.
Risk management strategies are affected by someone’s ability to bear or take risks. Risk bearing ability is related to the solvency and liquidity of one’s financial position. To show the differences in risk bearing ability, Table 1 below shows three farmers’ balance sheets and cash flow statements for operating 400 acres with the same type of machinery. From a cash flow and financial position of the business standpoint, Oscar is able to assume more risk than either Sam or Bob. Sam requires less cash annually than Bob and has a larger cash flow cushion, Bob does have a larger net worth based on which to fall back. For example, a 16.7 percent or $20,000 reduction in gross farm income ($10,000 in the case of Sam) results in a cash flow shortfall of $6,000 for Sam and $12,000 for Bob. However, the $6,000 cash flow shortfall represents 12 percent of Sam's net worth, but the $12,000 shortfall is only 8 percent of Bob's net worth of $150,000.
Formulating expectations about the future is also a factor in decision making. For example, expected prices for corn and soybeans have some impact on farmers’ planting decisions. How individuals form their expectations is unknown. Formulating expectations is an important phase of the decision making process, and it involves judgement. Most farmers rely on personal experience but also use other information to make their decisions.
As you can see there are many different ways to look at and go about tackling risk in agriculture. You have to know who you’re dealing with and what you’re dealing with and whether or not you want to take that risk.
To read the full article and to take the risk quiz click here.