Ways to Manage Risk on the Farm

This article originally appeared in the “Better Farming magazine- Priaries edition” in November 2019.

A central aspect of running a successful farming operation is business risk management.

After all, so many factors – including weather and markets – are beyond producers’ control, so planning is essential to protect your business.

In this department, we focus on business risk management, providing insights and tools to help you build the resiliency of your operation.

To assist us in this inaugural article, we connected with a panel of industry experts, including

• John De Pape, president of Farmers Advanced Risk Management Co.
• Tyler Fulton, director of risk management at HAMS Marketing Services and a cow/calf producer
• A team of western Canadian Scotiabank advisers
• Moe Agostino, chief commodity strategist at Farms.com Risk Management (Risk Management is a Farms.com company, as is Better Farming.)

This month, we explore some short- and long-term business risk management issues and strategies western Canadian farmers should consider.

What three things should producers do between November and March to reduce their risks for the 2020-21 marketing year?

The interviewees focused on three themes:

1. Market awareness. Spend some time examining the markets for your current commodities. What factors will drive 2020-21 experiences in these markets?

2. Diversification. Consider the mix of crops and/or livestock that you produce. Can you try some new crops or incorporate new feed sources in 2020? You’ll need several years to make any substantial changes to your operation but think of the steps you can take in 2020 to initiate this process.

3. Hedging and forward contracting. Crop, feed and livestock prices are volatile. If you haven’t looked at locking in your prices yet, make the winter of 2019-20 the time to learn more about this task. If you have begun this work, perhaps also look at currency exposure, since many of our Canadian commodities have a direct tie, through basis, to the U.S. exchange rate.

Given the stage of our economic cycle, what should producers consider doing to strengthen their balance sheets?

Looking at the Canadian and global economies, many pundits suggest that we are at the precipice of an economic slowdown or recession. If this situation occurs, then equity markets could fall, unemployment rates could increase and loan losses at financial institutions could rise. If these events happen, it’s hard to imagine they won’t have direct effects on agriculture.

We still have historically low interest rates. In a capital-intensive industry like agriculture, interest rates can be a very substantial input cost, so producers should revisit the trade-offs between variable and long-term fixed interest rates.

For this question, our experts focused their suggestions on two themes: liquidity and relationships.

Farmers should take advantage of the relative stability in the current financial markets to build as much flexibility into their balance sheets as possible.

 “From a hog producer standpoint, when we see hog prices increase, producers need to rebuild their cash reserves in order to build resilience,” said Fulton. “The nature of the market impacted by an uncontrolled animal disease such as African swine fever may require producers to dip into these reserves in the event that the disease is found in either the U.S. or Canada.

“The short-term cash requirements (needed) to deal with such an event could be very significant, but producers can protect against long-term impacts by preparing in the good times,” he added.

And the benefits of a stronger balance sheet are not limited to tight years.

“Cash is king,” De Pape said. “Many farmers don’t recognize the importance of holding cash reserves. Marketing opportunities are much greater when you aren’t forced to sell for cash flow.”

In order to weather difficult conditions or build your business, relationships are key.

Take the time to develop a team of advisers you trust and with whom you feel comfortable. This team should include individuals with legal, accounting, finance and risk management skillsets.

Meet with your bankers and finance partners to help them understand your business and your goals.

These experts can help farmers weigh their options between leasing or financing, fixed or variable interest rates, and new or used equipment, he added.

This year was unusual in terms of weather patterns, threats to quota and global trade challenges. How should producers look at risk management in the future?

Farm managers and owners must assess the risks they face in their businesses. Producers must stay informed of market developments and broaden their views of risk.

 “The world is getting smaller,” Agostino said. “As an industry that exports greatly, producers must be aware of what is going on around the world. Whether it be the China and U.S. trade agreement, drought in Brazil or currency manipulation, the speed of impacts on Canadian agriculture seems to be getting faster and more direct.”

While “there is likely little that we can do to directly affect these events in foreign lands, the news and the impacts should not be foreign to us as business people,” he added.

We also need to look beyond the more traditional risk management tools of property and crop insurance. We face more risks than simply weather and market volatility.

A business cannot operate without its employees, such as the owner, family members or non-family staff. What would happen to our farm operations without our employee base? What can we do to mitigate this risk?

We can invest in disability and life insurance for the farmer-owners. We can talk with our family members about their goals. We can complete performance evaluations and goalsetting with employees and conduct compensation reviews to ensure we’re offering competitive wages and benefits.

“Successful risk managers consider the probability of an event occurring and the impact that the event may have on their operations,” Fulton said.

“In my experience, when producers start to think about their risks in this way and relate them to their specific operations, they become better, more consistent managers. They experience less regret in their decision-making over the long term.”

Agostino agreed. “I encourage producers to talk about risk with each other. They should highlight items that they believe are risk areas and share what they have done to address those risks,” he said.

“Often, it’s not the answers that producers need help with. Rather, it is building an understanding of the questions that need to be asked.”

We typically don’t anticipate or plan for black swan events, given their low-perceived probability. If these events occur, however, the surprise and effects are often quite negative. So, how can producers identify these risks and protect themselves?

The challenge with black swan events is that their rarity suggests we don’t need to plan for them. But, while floods and tornadoes might be rare, we expect our governments to have disaster and emergency relief plans ready.

For producers, the challenge is to imagine the types of events that could happen.

Drawing on his experiences as a beef producer, Fulton pointed to worries about animal disease outbreaks in the industry.

“As the BSE crisis proved, the Canadian livestock sector is highly reliant on export markets. Farm organizations like the Canadian Cattlemen’s Association and the Canadian Pork Council are doing great work and remain focused on mitigating the risks associated with an outbreak. But producers (also) need to remain vigilant in preventing the risk and mitigating the impacts at the farm level.”

 Jesse Loyns, a director of national accounts with Scotiabank’s agricultural banking team in Saskatoon, Sask., provided a couple of examples on the crop side, such as consecutive years of flood or drought, or total crop failures. 

 Let’s look further down the road. From a business risk management perspective, what should every producer do by the end of 2020 to set him- or herself up for success in 2025?

Since we are looking longer term, the number of opportunities that we can consider increases because we have a longer period for implementation. From a cropping perspective, producers should consider the adequacy of their on-farm storage, De Pape said.

“I’d like to see a cultural shift in farm risk management aimed at more fully embracing the need – and power – of ample on-farm storage,” he said. “On-farm storage (is) an integral part of a sound marketing and risk management strategy; (being) ready to exploit the full benefits of storing grain is essential to getting the most out of the market.

 “Like selling for cash flow, selling due to a lack of space can cost in terms of missing marketing opportunities,” he added.

Producers should also consider ownership dynamics and transition plans.

As a first step, “every farmer should make a resolution to have an updated will by the end of 2020,” Agostino said. “For those individuals with a current will, they should focus next on strengthening their businesses’ foundations by creating five-year operating plans. These plans will hopefully become the centrepiece for dialogue amongst the family or ownership group.”

Loyns agreed. “Implement a five-year plan. It is important to have a strong vision and defined goals so that you can plan appropriately and take the necessary steps to achieve those goals,” he said. 

Looking ahead

You can draw on the experiences of your peers and work with a panel of advisers to identify both short- and long-term risks. Together with your advisory team, you can implement strategies to protect and strengthen your farm operations.