In this Issue:
VEGETABLE NEWS
A RISK MANAGEMENT AGENCY FACT SHEET
APPLE NEWS
STRAWBERRY NEWS
White Grubs in Blueberries and Strawberries
Please Note: the next newsletter will be published August 11.
| Vol 3 No. 9 | July 21, 2006 |
A Risk Management Agency Fact Sheet - Program Aid Number 1667-03, May 2000
As mentioned in Issue 1, we have been awarded funding provided through partnership agreements with the Minnesota Fruit and Vegetable Growers Association and the United States Department of Agriculture – Risk Management Agency (RMA) and the RMA Community Outreach and Assistance Partnership Program. Below is an excerpt from a RMA publication discussing grower risk.
The entire publication is available at: http://www.rma.usda.gov/pubs/2000/PAN-1667-03.pdf
What Is Risk?
Every business and every person faces risks each day, but what is risk? People have different attitudes about risk. Some will wager a week's pay at a casino, while others will hide their money under a mattress. A person's aversion to risk is a key factor in the extent to which they will try to manage their risks. In general terms, people often think of risk as the chance of something bad happening. “Bad” and “chance” are two key elements of risk. In financial terms, risk is the possibility of financial loss.
“Bad” is the first element, and it refers to an event or outcome that is adverse, such as a crop failure. “Bad” is also relative - losing more money is worse than losing less money.
“Chance” is the second element. Risk involves uncertainty that an adverse event will occur. If something “bad” is absolutely, positively, guaranteed to happen, there is no risk because uncertainty isn't present. For example, there is no risk associated with jumping out of an airplane without a parachute. You will perish, guaranteed. It's stupid, but not “risky.” Jump out of the plane with a parachute, and you'll probably live, but there's a chance you won't. Thus, most people consider sky-diving risky and jumping out of the plane without the parachute suicide. This example is extreme, but it is important to note that risk management will not help the individual intent on jumping without a chute. In business terms, a business must be economically viable and the individual must be willing to use risk management for risk management to be effective.
What Is Risk Management?
Risk management, in a business context, is about reducing the cost of risk, which includes the cost of managing risk. Business, including farming, is about making profits or gains. Farmers need money to make a living for themselves and their families. To make a living, farmers must take risks, investing $200,000 or more worth of seed, fertilizer, and herbicides and hoping for rain but not too much rain. Farming is risky; one doesn't know what the outcome will be when the crop is planted (the “chance” element), as all or a portion of the crop could be lost (the “bad” element). Because farmers take this risk, we have a plentiful food supply.
The first key concept of risk management can be expressed by the old saying, “nothing ventured, nothing gained.” Risk management involves asking the question, “Is the risk appropriate for the return?” Is the farmer venturing too much for too little gain, i.e., will the farmer make enough profit to reasonably justify the risk? The word “reasonable” is key.
Risk management, in a business context, is about reducing the cost of risk, which includes the cost of managing risk. No business is risk-free, and risk management won't eliminate all risks. Risk management is about 3R's: returns, risks, and ruin.
Don't Risk a Lot for a Little
The more risk you take, the greater the reward you should expect….. Are there any risk-free investments? Yes. U.S. Treasury bills are generally considered “risk-free.” The U.S. Government is unlikely to default on its bills. If you buy a T-bill, you can be as absolutely certain as anyone can be that you will be paid exactly what you are owed. The dollar may not be worth as much, but you will get paid. A T-bill is about as risk-free an investment as you can find. In January 2000, a T-bill paid about a 5 percent return….. If you can obtain a 5 percent return with no risk (T-bill), would it be financially wise to invest in a stock that would only make a 4 percent return? No - why incur a higher chance of losing your money to make less than you could get with no risk? This is a key concept of risk management. In order to justify making a higher risk investment, one should expect a higher return on the investment. The more risk, the higher the chance of a loss, so the potential gains from other similar investments need to be high enough to make up for the losers.
How do the returns from farming fit into this? Averaged over all farmers, farming yields a return on equity of 2 to 3 percent. Like any average, some farmers earn much more while others earn much less. Many farmers earn less on their equity than they could make by investing in a risk-free T-bill.
Planting a crop is an investment decision. Any business person, including a farmer, should continually ask if they could use their assets to make money some other way, if financial gain is important to them. When the returns don't justify the risk, enrolling in the Conservation Reserve Program (CRP) or cash renting their land are ways farmers can earn a less risky return on their assets.
Don't Risk More Than You Can Afford To Lose
No one should invest more than they can afford to lose, unless they want a drastic change in their lifestyle, because sometimes they'll lose. Ruin is the result of losing more than you can afford. Unfortunately, to support a family by farming, some farmers must face the possibility of ruin each year. Crop insurance helps reduce the chance of ruin by reducing the maximum amount of money they can lose. Still, in today's economic climate, ruin is a real issue for farmers.
Know the Odds
A coin toss is a 50-50 proposition. A roll of a die is a 1-in-6 event. What are the chances that this year will bring a drought? And, if it does, how much revenue will be lost? No one knows precisely, but estimates can be made based on historical data, and these estimates can be invaluable in making an investment decision. RMA has developed and is developing tools to help farmers estimate the chances of profit or loss. The odds may be in a farmer's favor, but sometimes they still lose. That is why avoiding ruin is important - it allows a farmer to keep farming. A loss doesn't put them out of business.
It is very important to realize that the odds of making a profit or of ruin change every year, and a losing year can make the odds of either much worse the next year. “Losing years” must be paid for by borrowing or by using equity built up in good years. The greater the debt or the less equity a farmer has, the harder it will be for the farmer to pay the bills if another loss occurs. Thus, it is very important that farmers understand their true financial situation, including not only preparing cash flow projections, but also preparing a balance sheet and income statement. One can have a positive cash flow and still lose money.
Putting It All Together
A good set of financial statements is critical and is a prerequisite for risk management. Financial statements describe the assets and liabilities, sources of financial risk, and the profit or loss of the business. For risk management to be effective, the business must have a reasonable expectation of making a profit (assuming financial returns are important).
Risk management cannot make a business that is fundamentally not profitable, profitable. With financial statements, a farmer can then apply these guiding principles to assess his or her risks in the context of other financial investments. Then, a farmer can analyze various risk management strategies to help bring the expected financial returns in line with the risks. Done well, risk management can help protect a farmer's hard-earned money from the risks associated with farming.
Conclusions
RMA's mission is to encourage farmers to proactively manage their risks. Farming is risky, more so than many other businesses. For taking these risks—and feeding the world—some farmers earn a good return on their investment. Others do not. By practicing risk management, farmers can gain greater control over their risks, financial returns, and solvency. For more information, see About the Risk Management Agency (PA-1667-02) or visit us online at http://www.rma.usda.gov/.
1-Minute Risk Management What: The effective risk manager assures financial solvency against the consequences of risk at the lowest possible cost.How: Understanding financial statements provides the foundation on which a sound risk management plan can be devised and appropriate risk management tools employed. Guiding Rules: Don't risk more than you can afford to lose. Don't risk a lot for a little. Understand the likelihood and severity of possible losses. Source: Mehr and Hedges, Risk Management in the Business Environment, Irwin Press, 1963. |
ACKNOWLEDGEMENTS
Co-Editors: Bill Hutchison (hutch002@umn.edu), Department of Entomology, University of Minnesota, Jeanne Ciborowski, Minnesota Department of Agriculture, Ag. Resources Management and Development Division, and Suzanne Wold-Burkness (woldx018@umn.edu), Department of Entomology, University of Minnesota
The Newsletter is published weekly from May through August, cooperatively, by the Minnesota Department of Agriculture (MDA) and the University of Minnesota (U of MN). Reports are posted on the U of MN and MDA web sites on Fridays. If you have suggestions and/or comments, please send your contributions by 4 p.m., Wednesday to Jean Ciborowski, 651-201-6217, jeanne.ciborowski@state.mn.us, MDA, 625 Robert St. North, St. Paul, MN 55155-2538. You can access the Newsletter at the U of MN web site in htm format at: www.vegedge.umn.edu/MNFruit&VegNews/mnindex.htm and at the MDA web site in pdf format at: http://www.mda.state.mn.us/ipm/ipmnews/
Partial funding for this publication is provided through partnership agreements with the Minnesota Fruit and Vegetable Growers Association (MFVGA) and the United States Department of Agriculture – Risk Management Agency (RMA). These institutions are equal opportunity providers.
DISCLAIMER
Reference to products in this publication is not intended to be an endorsement to the exclusion of others which may have similar uses. Any person using products listed in this publication assumes full responsibility for their use in accordance with current manufacturer directions.
The University, including the Minnesota Extension Service, is an equal opportunity educator and employer. ©1999-2006 Minnesota Extension Service, University of Minnesota. All rights reserved. Contact copyright@extension.umn.edu for information on reproduction or use of this material.