Farm Horizons, August 2011
How do you manage risk?
When you hear, “risk management,” do you just shake your head and wonder what is coming next? Risk management isn’t a scary topic, really. We all do some form of risk management almost every day. Do you fill your vehicle when you are down to a quarter-tank? That is managing the risk of running out of fuel and having to walk or be rescued.
As a farm owner, you have several tools available to manage risk.
• Crop insurance is a key form for most operations I can go out and buy coverage that will guarantee me a certain level of revenue per acre. Just like other insurance, the higher the coverage that I buy, the higher the premium.
• We also have margin insurance we can buy as a livestock producer. This has been promoted a lot for dairy producers, in which you buy revenue insurance or gross margin overfeed cost insurance.
• In addition, we typically buy vehicle insurance, building insurance in the form of wind and fire policies, and general liability coverage, health insurance, dental insurance, long- term care insurance, and one could argue, life insurance as a form of risk management.
So far, all this insurance for risk management has an expense associated with it, so you are thinking that risk management is expensive, right?
It doesn’t need to be. Remember the first sentence about filling your gas tank? It is going to be the cost of the gas, whether you fill now versus filling 30 miles down the road.
We can do a similar thing in the grain markets, by going to the elevator or ethanol plant and selling 5,000 bushels of corn to deliver in November at a price of $x.xx per bushel cash price. You have agreed on a price, the basis is fixed, so at this point, your risk is to deliver 5,000 bushels of corn in November.
There is no other cost associated to this contract. So, if you have 200 acres of corn, and this is the only contract you have, your risk is relatively small.
If, however, you have only 20 acres of corn, this is still a huge risk, because even if you harvest 200 bushels of corn per acre, you would still need to buy the other 1,000 bushels of corn to fulfill this contract at whatever the price of corn is in November.
Crop rotation is another form of risk management, raising typically 50 percent of the crop as corn and 50 percent of the crop as soybeans. This is a form of risk management, because now we have divided the acres between two or more different crops, so that if one doesn’t do well or the price goes down severely before you can harvest and deliver, the other crop maybe won’t be as affected.
There are some other reasons we use crop rotations: it minimizes disease and insect issues, and a corn and soybean rotation reduces fertilizer costs.
Buying crop inputs over a period of time could be another form of risk management or even dollar management.
If a given input is not going to change in price over the next six months, there is no incentive or reason to borrow money to pay for it now. If, on the other hand, that item was expected to increase by 10 percent over the next six months and you could borrow money for 6 percent, then it would be a good decision.
Do you buy all of the fuel for your farm on one day? Probably not. You buy fuel as your storage allows, which is also a form of risk management. You risk the price being up or down when you need the next delivery, but you limit the exposure or the loss if the tank develops a leak.
Livestock producers often routinely vaccinate their animals against certain diseases in order to limit their exposure. Do you get a tetanus shot periodically, or a flu shot each year?
So, risk management doesn’t need to be a scary topic. Yes, some forms of risk management have a cost associated with them, but there are a lot of other ways that you, as a producer, can minimize the risk that your operation is exposed to. Spread out your purchases, spread out your delivery dates, and use your vaccinations to protect herd health and your health.