Risk is an important aspect of the farming business. The uncertainties inherent in weather, yields, prices, Government policies, global markets, and other factors that impact farming can cause wide swings in farm income. Risk management involves choosing among alternatives that reduce financial effects that can result from such uncertainties.
Five general types of risk are described here: production risk, price or market risk, financial risk, institutional risk, and human or personal risk.
Production risk derives from the uncertain natural growth processes of crops and livestock. Weather, disease, pests, and other factors affect both the quantity and quality of commodities produced.
Production risks relate to the possibility that your yield or output levels will be lower than projected. Major sources of production risks arise from adverse weather conditions such as drought, freezes, or excessive rainfall at harvest or planting. Production risks may also result from damage due to insect pests and disease despite control measures employed, and from failure of equipment and machinery such as an irrigation pump.
Price or market risk: It refers to uncertainty about the prices producers will receive for commodities or the prices they must pay for inputs. The nature of price risk varies significantly from commodity to commodity. Marketing risks relate to the possibility that you will lose the market for your products or that the price received will be less than expected. Lower sales and prices due to increased numbers of competing growers or changing consumer preferences are common sources of marketing risk. Marketing risks can also arise from loss of market access due to a wholesale buyer or processor relocating or closing, or if a product fails to meet market standards or packaging requirements.
Financial risk: It results when the farm business borrows money and creates an obligation to repay debt. Rising interest rates, the prospect of loans being called by lenders, and restricted credit availability are also aspects of financial risk. Financial risks relate to not having sufficient cash to meet expected obligations, generating lower than expected profits, and losing equity in the farm. Sources of financial risk commonly result from production and marketing risks described earlier. In addition, financial risks may also be caused by increased input costs, higher interest rates, excessive borrowing, higher cash demand for family needs, lack of adequate cash or credit reserves, and unfavorable changes in exchange rates.
Institutional/Legal and Environmental risk: It results from uncertainties surrounding Government actions. Tax laws, regulations for chemical use, rules for animal waste disposal, and the level of price or income support payments are examples of government decisions that can have a major impact on the farm business. In part, legal risks relate to fulfilling business agreements and contracts. Failure to meet these agreements often carry a high cost. Another major source of legal risk is tort liability – causing injury to another person or property due to negligence. Lastly, legal risk is closely related to environmental liability and concerns about water quality, erosion and pesticide use.
Human or personal risk refers to factors such as problems with human health or personal relationships that can affect the farm business. Accidents, illness, death, and divorce are examples of personal crises that can threaten a farm business. These relationships include those with family members, as well as farm employees and customers. Key sources of human resource risk arise from one of the “three D’s” — divorce, death, or disability. The impact of any of these events can be devastating to a farm. Human resource risks also include the negative impacts arising from a lack of people management skills and poor communications.
RISK MANAGEMENT STRATEGIES IN NIGERIA AGRICULTURE
Farmers have many options for managing the risks they face, and most producers use a combination of strategies and tools. Some strategies deal with only one kind of risk, while others address multiple risks. Following are some of the more widely used strategies.
- Enterprise diversification assumes incomes from different crops and livestock activities do not move up and down in perfect correlation, so that low income from some activities would likely be offset by higher income from others.
- Financial leverage refers to the use of borrowed funds to help finance the farm business. Higher levels of debt, relative to net worth, are generally considered riskier. The optimal amount of leverage depends on several factors, including farm profitability, the cost of credit, tolerance for risk, and the degree of uncertainty in income.
- Vertical integration generally decreases risk associated with the quantity and quality of inputs or outputs because the vertically integrated firm retains ownership or control of a commodity across two or more phases of production and/or marketing.
- Contracting can reduce risk by guaranteeing prices, market outlets, or other terms of exchange in advance. Contracts that set price, quality, and amount of product to be delivered are called marketing contracts, or simply forward contracts. Contracts that prescribe production processes to be used and/or specify who provides inputs are called production contracts
- Hedging uses futures or options contracts to reduce the risk of adverse price changes prior to an anticipated cash sale or purchase of a commodity.
- Liquidity refers to the farmer’s ability to generate cash quickly and efficiently in order to meet financial obligations. Liquidity can be enhanced by holding cash, stored commodities, or other assets that can be converted to cash on short notice without incurring a major loss.
- Crop yield insurance pays indemnities to producers when yields fall below the producer’s insured yield level. Coverage may be provided through private hail insurance or federally subsidized multiple peril crop insurance.
- Crop revenue insurance pays indemnities to farmers based on gross revenue shortfalls instead of just yield or price shortfalls. Several federally subsidized revenue insurance plans are available for major crops in most areas of the United States.
- Household off-farm employment or investment can provide a more certain income stream to the farm household to supplement income from the farming operation.
- Most producers use a variety of farm management strategies and tools, and since risks and the willingness and ability to bear risks differ from farm to farm, so do the risk management strategies used.
- Article by Michael Sciabarrasi, Extension Professor (Retired), Agricultural Business Management, UNH Cooperative Extension.
Written by Oyafunke Olatomiwa