Uncertainty is an unavoidable part of any farming business. Starting from weather predictions for the entire year to calculating the increase or decrease in market prices, agribusiness owners are forced to make decisions based on inadequate information. Such uncertainties create the possibility of injury or loss.
Risk implies the possible adverse results that arise from uncertainty and insufficient knowledge in making decisions. For example, every time a farmer plants his fields, there is a possibility of the weather destroying the crops; or, every time any feed-lot operation purchases calves, there is a possibility of loss due to a fall in beef prices.
There are five general types of farm risks:
- Production Risk: As the name suggests, this type of risk comes with uncertain natural growth processes of crops and livestock. The quality and quantity of commodities get affected by weather, disease, pests, and other such factors.
- Price/Market Risk: This type of risk deals with uncertainty about the prices the farmers will get for products or the prices they have to incur for inputs. The nature of the price risk varies from product to product.
- Financial Risk: This type of risk arises when the farm business borrows money, creating the need to repay debt. There are several aspects of financial risk including rising interest rates, the prospect of loans put forward by lenders, and the restricted availability of credit.
- Institutional Risk: Uncertainties from government actions create institutional risks. For example, tax laws, regulations for chemical use, rules related to animal waste disposal, and price level or income support payments.
- Personal Risk: This type of risk involves problems related to human health or personal relationships that affect farm business, for example, accidents, ill health, death, divorce, etc.
Due to the ever-changing structure of the agricultural industry, managing risk has become essential for the success of agricultural operations and financial risk is one such risk. Financial risks arise due to the need for finance in business operations and to maintain cash flow levels to repay debts and meet other financial obligations. Securing essential loans is essential to several farm operations. At the same time, borrowing money brings numerous risks. All such risks are influenced by economic factors and changes in financial markets which are usually beyond the individual farmer’s control. Additionally, changes in market values of loan collateral also affect agricultural producers’ ability to ensure a profitable enterprise.
In this blog, we have enlisted the different types of tools to help farmers manage financial risk.
Financial Risk Management Tools
There are different management tools that help farmers manage financial risks. Having an overview of the tools available for managing financial risk can help agricultural producers formulate better market research plans that can minimize those risks and maximise profitability.
- Records: Knowing the financial situation of a farmer is the key to minimizing financial risk. Having a good farm record allows farmers to evaluate their current position and determine if he is moving in the right direction. Apt financial records (including balance sheets, income statements, cash flow statements, etc.) help farmers in Australia to understand the financial risks better and determine what areas need improvement. To make an informed decision, knowing the current debt-to-asset ratio will be beneficial in securing loans and getting a low interest rate on loans by lowering the ratio. Cash flow statements allow farmers to get an idea about the trends in revenue and expense levels that helps ensure adequate cash flows to meet financial obligations. These statements are beneficial in managing marketing risks too.
- Smart Loans: Loans that are secured for a large sum of money or a long duration will get you a fixed interest rate, reducing the financial risk associated with the loan. In the later years of the loan, the variable interest may increase, making repayment difficult or impossible. Contrarily, while the fixed interest may be slightly higher than the beginning of the loan, the cost of the loan will not increase over the loan’s lifespan. At the same time, self-liquidating loans also help minimise financial risk. These are the loans that can be repaid by the productivity of what the loan was secured to purchase, like loans for crop production, and dairy cows or feeder cattle. Farmers can pay off crop production loans by selling the crop and repay the loan for dairy cows by selling the cow’s milk.
- Reserves: For protection against the impact of financial risk, farmers can maintain liquid and credit reserves. A liquid cash reserve or other liquid assets can be used if needed to mitigate any financial difficulty. At the same time, there are financial institutions that offer different types of credit lines and several farmers borrow amounts below their imposed credit limits. These credit reserves allow farmers to get additional loan funds if needed.
- Renting/Leasing: Another great means to minimise financial risk is by renting or leasing land or machinery that allows farmers to avoid the financial risk associated with a large land loan. However, there may be other human and legal risks involved with these rental and lease agreements that the farmers should be aware of.
To get a deeper insight into farm financial risk management in Australia, browse through the KG2 Australia website. We are Australia’s largest independent farmer database that enables farmers and industry to leverage the most comprehensive agribusiness database. For more personalised assistance, contact us!