Understanding Risk is Key to Managing Risk
by Elena Brookover, Risk Manager, email@example.com With recent volatility and big price swings in Ag markets, risk management is on everyone’s mind. Business advisers tell you to manage your risk (and you should!). But before you can manage it, you must first understand it.
Understanding your specific risk — and the very essence of what risk management is — can be the difference between a plan that lets you sleep at night or one that keeps you up all night.
Getting Started On Your Risk Management Plan
Before you start a risk management plan, it is important to understand why you would create one. On good years the weather is favorable, the markets are positive, and you sleep just fine. Risk mitigation in a year like that is an unnecessary outlay of time and money. But those of us who work and live in the business of Agriculture know those years aren’t normal.
Most years bring unpredictable weather, volatile markets, political change, and a lengthy list of other downside factors that leave you vulnerable.
Now that we’re in agreement on the need to develop a risk management strategy, let’s clarify two points about what risk management is and is not.
1. Risk management is NOT profit-driven
Sometimes the two coincide but an effective risk management plan focuses on limiting your downside exposure, not increasing profits. With that in mind, some risk management tools carry a cost, but they could also be the difference between staying in business and losing it all. Look at it like a homeowner’s insurance policy in that regard.
2. Risk management IS identifying risk and then assessing actions to mitigate its impact
While attending a risk management seminar presented by CattleFax, we were introduced to the phrase “You can’t manage what you don’t measure.” We take that statement a step further and say, “You can’t manage what you don’t write down.”
Wanna Manage It? Write It Down!
Take a look at your operation and identify which risks you can control and which risks you cannot. For example, you can control what crops you plant, but you can’t control the weather. Simple as it sounds, writing it down — and even displaying your “risk list” where it’s visible every day — is an effective way to change your perspective on risk.
Now that you’re armed with your “risk list” and you know which factors are in and out of your control, let’s look at risk management options. You can: accept, avoid, transfer, or reduce your risk.
Most people like to avoid risk whenever possible. However, your business is production Agriculture where you’re a price taker (you don’t set market price) and you certainly don’t control the weather. Therefore, risk avoidance isn’t much of an option for you. You’re left with accept, transfer, or reduce.
We all accept a degree of inherent risk associated with life and business. Your acceptability tolerance will vary based on financial position, age, personality type, and — obviously — the amount of potential burn. Most of us aren’t willing, nor would it be prudent, to accept 100% of the risk facing our business or our productive output.
Transferring risk is exactly as it sounds — you pay a premium payment to transfer a potential downside onto another entity, thereby protecting yourself and your business. Crop insurance programs and Livestock Risk Protection products are effective tools to transfer risk.
You can reduce price risk by hedging your commodity. Tools at your disposal involve various methods to lock in pricing, limit downside impact, and profitably sell crops and livestock.
Now That You Understand Your Risk, Let’s Manage It!
In Agriculture, there is no such thing as risk avoidance and there are limits to the degree of risk any of us can accept. For your farming and ranching legacy to live on, you must utilize the right tools to reduce and transfer risk. A firm understanding of what risk management is — and is not — along with a written and visible “risk list” will keep you focused on risks you can control and the four methods to do so.
At Silveus Financial our experts integrate crop insurance, commodity marketing, and government program interpretation to protect our clients. Reach out to us at 800-747-1951 or find us at www.silveusfinancial.com.
DISCLAIMER: The risk of loss in trading futures and/or options is substantial, and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results.