FBM Chapter 11 - Risk Management

Risk Management Introduction

• Sun Tsu's quote, "If you know your enemy and yourself, you will not be defeated in a hundred battles," emphasizes the importance of understanding both internal and external factors for organizational success. Risk management is a crucial process for looking at the external environment, identifying threats, and defending against them while learning the firm's internal processes.

Risk Explained

• Risk management is a process requiring managers to learn about their businesses and the threats that endanger them. This learning allows better identification of threats and mitigation strategies.
• Risk is pervasive and inherent in all endeavors. Left unmanaged, risk can destroy the value of efforts.
• The worst case for a business is bankruptcy and asset loss. Risk management is crucial for defense.
• Risk is defined as uncertainty. This uncertainty exists in daily events and farm operations.
• Fear of the unknown (uncertainty) hinders managerial decision-making, harming a business's potential.
• Effective risk management provides clarity on potential downsides of decisions.

Risk Management Process

• Risk management is a multi-step process. The process involves identifying and minimizing exposure.
• It is a 5-step process: identify, monitor, prioritize, plan, and implement.
• Risk management is an ongoing, continuous process, requiring updates to reflect changes in operations.

Identifying Risks

• Risk identification begins with a risk audit of the farm's environment.
• This process assesses potential risks, and evaluates the exposure (potential loss) the farm faces.
• The USDA risk framework categorizes risks into 5 types: Market, production, financial, legal, and human.

Market Risk

• Market risk is the fluctuation in commodity prices.
• Exposure lasts from the initial production planning to sale.
• Market risk is particularly relevant for producers of longer-production-cycle commodities.

Production Risk

• Production risks deal with the yield of agricultural products.
• Factors like weather (storms, floods, hail, etc.), diseases, insects, and accidents all contribute to production risks.
• Loss from production risks have direct and indirect components. A direct loss is the loss of assets directly impacted, while an indirect loss is the loss of potential income.

Financial Risk

• Financial risk deals with the capital structure and financial flows of the farm.
• Solvency is the ratio of debt to equity. High debt ratios increase the risk of bankruptcy.
• Liquidity refers to a firm's ability to pay debts when due, preventing financial strain. Cash flow is critical, ensuring daily operational costs are covered.

Legal Risk

• Legal risk involves potential legal liabilities.
• Legal liability covers injuries or property damaged to others on the farm.
• Two broad categories of legal liabilities are risks from properties and risks from activities.

Human Risk

• Human risk concerns the safety of farm workers and owners.
• Farm work can be hazardous; therefore, injury or death are possible risks.
• The potential for injuries arises from equipment, farm chemicals, and specific farming activities.

Prioritizing Risks

• Risk management must prioritize risks based on their potential impact.
• Prioritizing helps determine which issues require immediate attention to minimize harm.
• The order of risk prioritization should consider which risk is most likely to cause farm bankruptcy.

Risk Management Plan Implementation

• Implementing a risk management plan involves putting controls in place, ensuring sufficient funds are allocated to manage retained risk, and transferring remaining risk through insurance when appropriate.

Monitoring Risk Management

• Ongoing monitoring of implemented plans is crucial for success.
• Regularly evaluate the effectiveness of control measures, track and process claims, and adjust plans as necessary.

Risk Management Plan Updates

• Risk management plans must be updated whenever farm circumstances (acreage, operation changes) change. Updated plans are key to effectively managing risks.

Sample Risk Management Plans

• Sample plans illustrate how to assess, prioritize, and implement controls, transfer, or retain specific risks.