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Managing Risk in Your Business

01/03/2007


There is risk associated with every aspect of business, whether you are farming or in some other business. There is no possible way to eliminate all risk. Therefore, it is crucial that farmers manage the risks that are associated with their farms.

Understanding the different risks that are associated with farming, and where these risks present themselves is critically important when trying to manage risk in your business.

Top-of-mind when talking about risk in farming is financial risk. Risk in the marketplace is also a major area of focus and an area in which many farm business managers commit less than adequate time.

Two areas of risk that receive less attention, but potentially can have disastrous consequences are event (or crisis) risk and asset risk. Firstly, we will address event risk. The BSE situation is a classic example of event risk. But for purposes of this article, we will use two other real-life examples.

The first example is a Manitoba PMU (Pregnant Mare Urine) producer .The PMU producer had a contract to deliver product to the processor in Brandon. The producer had recently renovated the existing facility, including upgrades in the storage area, and added an extension to the building to accommodate additional mares. These decisions were made in the belief that the industry was relatively stable and there was opportunity to expand production.

The producer had been a large grain farmer and in the late 1980s decided to venture into the PMU industry as a diversification effort and to address risk he believed existed in grain farming. Over a period of about 10 years, the farmer increased his focus in the PMU business and gradually phased out of grain farming. The PMU industry was challenging with increasing public scrutiny on animal welfare and increasing processor focus on product quality and standards. But, the return on investment and labour was quite good.

The second example is the potato producer. The farmer was almost completely focused on potato production, having over a period of years and similar to the PMU producer, phased out of grain farming. There was excellent opportunity in the potato business, but potato production is extremely demanding both from a labour and management perspective. Again, similar to the PMU industry, the processors were, in response to their customers and ultimately the consumer, demanding more intensive management and better quality. The producer had expanded production to over 600 acres and was quite heavily leveraged (financed). There is a large capital investment required to be in the potato business, and the annual operating investment costs can exceed $1,300 per acre.

In both instances, the farms were well established and had considerable experience in their respective sectors. And in both instances, the processor informed the farmer that their contracts were being cancelled. Also in both examples, the notification came after the annual production cycle had started. In the PMU case, the mares were already in the barn and production had commenced and in the potato case, some of the potatoes had already been planted and more of the land had been prepared for planting. Each farm suffered a significant loss in equity and each farm had its existence threatened.

In each of these situations, the event was beyond the control of the farmer. This is the very essence of risk. Things coming out of the blue and things over which you have no control. So what to do?

In managing risk in your farm, it is far better to be proactive and as prepared as possible to deal with risk as it occurs, than it is to be reactive. But as in the situations above, things can happen that can only be handled reactively. Whether you are trying to be proactive, or are faced with reacting to something that has already happened, there is a process that can be used to help you through the situation.

The process involves five steps:

Identification
Requires that areas where risk can exist within your business be identified. This is a process that is best managed by talking to an advisor who has a good understanding of your business and the industry in which your business exists.

Assessment
Requires that the impact of the risk be quantified and qualified.

Quantified from a financial perspective. The potato farmer had to determine what the financial impact was given the investment he had already made in the crop and what impact this would have on his ability to meet his financial commitments.

Qualified from a personal, family and business perspective. For example, in the PMU situation, the event had impact on the farm family because there was a process underway to begin to transfer the ownership and management of the business to the next generation. The cancellation of the contract required that the farm family take another look at the plan to transfer the farm.

Mitigation
Requires that plans be developed to manage or minimize the impact of the risk. Depending on the risk identified, the plans can range from being quite basic to quite detailed.

Implementation
If you are reacting to something that has happened, then you will be actually putting the plan into action.

If you are proactively planning for potential risk, then the implementation step is simply to document the plan in writing.

Evaluation
On an ongoing basis, plans should be evaluated to determine their effectiveness in dealing with real or potential risk.

Both the PMU and potato farmer are managing through the events that hit them unexpectedly. Both had not planned for a risk of this magnitude and both will admit that planning to manage risk within their businesses was less than adequate.

Given the capital investment required to be in the business of farming and given the very nature of farming where risk is high and margins are narrow, it is increasingly important for farmers to take a more proactive approach to managing risk within their business!

Next time we will discuss the implications of asset risk.

A recent study conducted in Western Canada on the management practices of leading farmers by the Best Practice Group found that 36.8% have a written risk assessment plan. You can complete the Best Practice Group management self-assessment online at www.leadingfarmers.com.

By Terry Betker, Director, Agriculture - Industry & Government. Originally published in Moosomin World Spectator (March 28, 2005). For more information, please contact your local MNP advisor or Terry at 204.788.6055.