In the business of farming, risk is a constant and whether you know it or not, you are making risk calculations and employing risk management strategies all the time on your farm.
Some risks are more significant or front of mind than others, like the weather, but there are many different types of risks faced by farmers that are not often considered, like succession planning.
It’s important to remember that risk is something you can manage. In fact, formalising your on-farm risk appraisal and risk management processes can be very beneficial.
What is risk?
The simplest way to define risk is uncertainty of outcome. The risks in your business are any areas where the outcome is unknown. People get caught up thinking that risk is negative but in fact it is a neutral factor that can have either negative or positive outcomes for your business.
Just as every farm is unique, the risks and possible effects on business will vary from one farm to another. There are some risk areas that are common across most farming businesses:
- Production/yield risk –the risk that yield might be lower than expected due to extreme weather events/change (including drought, frost, too much rain), weeds, pests or disease, or machinery and equipment failure.
- Personal and operational risk – injury, sickness and changed family relationships (think death, divorce and disability), as well as disruptions to operations caused by human error when handling machinery or working on the farm.
- Price/market risk – the possibility that you may lose the market for your product, or the price you expect to receive is not met and sales are impeded. Lower sales and prices due to increased competition or changing consumer preferences are common sources of this risk.
- Financial/legal risk – financial risks include not having enough cash to meet obligations and legal risks include failure to fulfil agreements or contracts. This may be brought about by production and market risks or by increased input costs, higher interest rates, changing exchange rates, excessive borrowing, or higher cash demands to meet family needs.
- Succession planning – the risk associated with succession. It may be that you don’t have a succession plan, you haven’t planned ahead and are trying to rush one through before you retire, the plan is disputed by family members, or that it is simply insufficient in terms of securing the future of the farming business.
What is the risk in having unchecked risk?
Obviously, when we’re facing the unknown, the ideal outcome is a favourable one for your business. It follows that a significant part of good business management should be devoted to maximising your chances for positive outcomes while minimising the chances (and the effects of) negative outcomes.
When it comes to dealing with risks in farming, the absolute worst thing you can do is nothing. When risks are left unchecked or unmanaged, in addition to the inherent outcome, it can also cause a lot of stress and additional work and expense dealing with the fallout.
However, effectively managing risks is an excellent way to bring structure and discipline to your business and help to reduce the pressure you’re under. Facing the risk head-on by trying to understand what’s ahead and planning for the outcome you want is the smartest way to manage risk. In short, better risk managers make better farm managers.
How do you manage risk in farming?
Good risk managers make decisions quickly and decisively. Ask questions, seek information and look at the whole picture. As far as possible emotion is set aside.
Farm managers accustomed to managing risk make calculations and clear decisions. You need to identify areas of uncertainty of outcomes, then you need to calculate the chance of incidence by the degree of consequence. Next you need to ask yourself, ‘which way do I want to be wrong?’ and you’ll soon know what you should do.
For those new to risk management thinking, it is helpful to break it down even further into these five key steps to develop a Risk Management Plan:
1. Identify your sources of risk
This involves an honest assessment of your farm and business processes, challenging your default or traditional thinking (i.e. looking beyond doing things simply because that’s the way it’s always been done), neutralising risk (stop thinking of risk as negative, or avoiding it altogether), and arming yourself with information. Ask questions, seek expert advice and be ready to pay for it – it’s an investment that will pay dividends in the long run.
2. Measure the likelihood of that risk occurring
How likely is it that this thing will happen? Thinking of a scale from very unlikely to very likely can help.
3. Estimate the effect on your business
In the event of that risk occurring This may be in terms of profit and/or asset value over time.
4. Create a risk score and rate the risks
Risk score = Likelihood of occurring (chance of incidence) x Effect on your business (degree of consequence).
5. Determine the strategies you can adopt to manage your risks.
This is where you formalise your thinking in writing. Best written when you’re not facing any major decisions or under stress, your plan documents the various risks you’re likely to encounter and maps out the actions you will take at what point in time for the type of consequence you’re willing to accept.
Strategies may include income diversification; crop, livestock, or credit insurance; marketing plans; negotiating or developing new production or sales contracts.
While you won’t be able to eliminate all the risks in your business, it is important that you spend the time assessing them and developing some realistic strategies. The aim is to manage those risks with the potential for greatest impact on your business and on your ability to reach your business goals.
You have to get on the front foot with risk management and you have to think objectively. Don’t rely on instinct, feelings or traditions; scrutinise your farm decisions and justify your actions according to considered business objectives and goals. Don’t wait until crisis hits. Do it now.
If you’re looking for specific advice in managing risks on your farm, it’s always a good idea to talk to your own team of experts, including your accountant, financial planner and agronomist/agribusiness advisor.
If you need help developing your risk management plan, call 1800 319 458 to book a free, confidential appointment with one of our qualified Rural Financial Counsellors.