developing a risk management plan paul e. patterson and larry d. makus university of idaho...

Developing A Risk Management Plan

Paul E. Patterson and Larry D. Makus

University of Idaho

Department of Agricultural Economics & Rural Sociology

Develop A Farm Plan

A farm plan is the umbrella under which other plans reside

Risk management is a component of each plan, not a separate plan

A Farm Plan Includes:

Goals & objectives Land use plan Crop plan Livestock plan Resource inventory Financial statement Budgets Income statement Supporting data

Planned vs Actual

Plans and decisions are made based on expectations

Evaluation should compare actual to expectations

Risk

Risk is the possibility that an outcome or event will not meet planned expectations

Risk Management

Risk management integrates production, marketing & financial decisions

Risk management is a planning process where you assemble and assess information

Every management decision carries risk management implications

Risk Management Requires

Understanding of Your financial situation

Understanding sources of risk and potential risk

Understanding of risk management tools

Risk Management Includes:

Evaluation of alternative plans & risk management strategies

Implementation of the plan

Monitoring the plan

Developing probabilities to formalize risk assessment

Probability

Probability is the chance orfrequency of an event

Probabilities quantify the chance of an event occurring

Probability

What is the probability that soft white wheat at Portland will be under $4?

What is the probability that your wheat yield will be below your 10-year average?

ProbabilityProbability

0%

5%

10%

15%

20%

25%

$2.75 $3.25 $3.75 $4.25 $4.75 $5.25

Price

Cumulative ProbabilityCumulative Probability

0%

20%

40%

60%

80%

100%

$2.75 $3.25 $3.75 $4.25 $4.75 $5.25

Price

Risk Assessment

Assess your risk bearing capacity

How much risk can you tolerate?

How much risk protection can you afford?

How much risk are you willing to accept

Managing Production Risk

Crop selection Enterprise diversification Spatial dispersion Cultural practices Preventative maintenance Risk Reducing technology Insurance

Managing Price Risk

Multiple sales

Contracts

Hedging

Market outlook

Managing Revenue Risk

Income Protection: USDA, RMA

Crop Revenue Coverage: private

* IP and CRC combine price & yield protection into a single program

Income Protection

Protects against a decline in actual revenue compared to expected revenue for a given year

Price protection varies each year

Crop Revenue Coverage

CRC Provides: Revenue guarantee, similar to Income

Protection Coverage Also provides replacement coverage,

allowing for increased coverage if price increases

Managing Financial Risk

Factors to consider Debt structure Leverage Resource control Business organization Production efficiency Insurance Reserve funds Off-Farm income

Managing All Sources of Risk

Education

Environmental awareness

Evaluating past decisions

Why Managers Don’t Plan:

Involves detailed thought & analysis

Reminds managers of uncertain future

May force manager to seek assistance

Forces families to address conflicts

Basic Risk Management Concepts

There is no one “Best Strategy” Balance the potential for a profit

against the potential for a loss The key to successful risk

management is taking the right risks Risk management does not eliminate

risk