Take steps to assess your risk management skills

As farms continue to consolidate it becomes increasingly important to assess a farm’s management skills.

At a certain farm size, it is no longer easy or feasible for the manager or managers to wear every management hat. How does the management team determine when to focus on professional development, delegate management tasks among managers, and seek outside assistance?

Management skills

The checklist below presents important risk management skills. I encourage you to rank your ability with respect to each skill using a 1 to 5 scale, with 1 being relatively weak and 5 being relatively strong with respect to that skill.

Risk Management Skill Checklist

• Manage production, financial, human, legal, and relationship risks.
• Develop written contingency plans to deal with future uncertain events, such as inability of the primary farm manager to perform regular duties.
• Maintain proper levels of life, health, property, and liability insurance.
• Crop insurance programs are implemented that provide balanced protection from hail, flood, and multi-peril causes.
• Are in documented compliance with regulatory requirements (licenses, environmental permits, etc.)
• Have actively managed interest rate risk through locking in longer-term rates on a majority of term debt.
• Written estate and succession plans are in place.

The idea behind checklists like these presented in the table is to assess whether a farm has a skills gap, defined as the difference between skills that a farm needs and the skills of their current workforce (operators and employees).

Conducting a skills gap analysis helps a farm to identify skills that will be needed to become more efficient.

The checklist does not include a final tally score, nor does it address tradeoffs in various skill or ability areas that may lead to success. Rather, the checklist helps farm operators evaluate their skills and abilities in areas critical to long-term financial success.

As farmers fill out the checklist, they should try to determine which of the skills listed are most essential to improving efficiency.

Risk management

I recently read research (Crane et al. 2013) that discussed nine steps involved in risk management planning.

The first step is to identify and classify risks. The second step is to measure or assess risks. Variability of outcomes and downside risk (i.e., the likelihood of low outcomes) are two common measures of risk.

Risk can also be assessed using scenarios. For example, when developing a business plan it is common to evaluate three scenarios: most likely, worst case, and optimistic.

The third step is to assess risk-bearing capacity, which is directly related to a farm’s liquidity and solvency position. A farm with strong working capital and solvency positions can take on more risk.

How risky are you

The fourth step is to evaluate risk tolerance or preferences. Risk-averse individuals are cautious risk takers. They often give up some income to mitigate risk. Risk-neutral individuals focus on income potential when making decisions.

The fifth step is to set risk management goals.

The sixth step is to identify risk management tools such as crop insurance, forward pricing, controlling leverage, and reducing the chance of a disease outbreak with preventive measures.

The seventh step is to select professional assistance in management areas where the expertise does not reside within the business.

The final two steps involve making a decision, implementing the plan, and evaluating the results.

Classifying risks

The five primary sources of risk include production, marketing, financial, legal, and human.

The first three sources are largely self-explanatory. Tools used to mitigate these risks include crop insurance, futures and options, and managing liquidity and solvency.

Legal risk may emanate from contracts, business organization, and laws and regulations. Human risk includes the following categories: human health and well-being, family and business relationships, employee management, and transition planning.

Obviously, from the list, even farms without hired employees (i.e., just use family labor) face human risk.

Strategic risk

Strategic risk involves the sensitivity of the farm’s strategic direction and vulnerability and sustainability of the farm to uncertainties in the business climate.

Strategic risk can also be thought of as the source of loss that may arise from the pursuit of an unsuccessful business plan.

Managing strategic risk often requires the development of alternatives or contingency plans. Using what-if scenarios can be useful. In addition to thinking about the possible consequences of a major decision, it is also important to think about how difficult it may be to unwind a decision if it does not go according to plan.

Bottom line

There is an important tradeoff between risk and return. Activities or investments with a higher expected return involve higher levels of risk. Similarly, activities or investments with lower levels of risk are often associated with lower expected returns.

Risk management involves optimizing expected returns given the risks involved.

In addition to managing production, marketing, financial, legal, and human risk, it is imperative that a farm assess and manage strategic risk.