Risk management is not crisis management

Risk management is not crisis management Risk management and crisis management are not the same thing, says Larry Madsen, Gettysburg, Extension area farm management agent for South Dakota State University.

Madsen believes risk management should not be seen as crisis management.

"Risk management is a proactive approach to directing a business," he said. "It is a popular phrase in farm policy, but it can apply to any business. It is farming with confidence in a rapidly changing world."

Madsen recommends a set of well-maintained financial records as an absolute necessity to maintaining financial control. The flow of information from past performance to planning for future accomplishments is critical.

Risk management is identifying risk events and contemplating methods available to deal with them. Risks can be categorized by type: production risks, financial risks, legal risks, marketing risks, human risks, said the agent.

Risk management is making conscious choices once the facts are known. It is not transferring all risk to others outside the business. It is balancing Risk and Profit. It is choosing strategies, which have the greatest probability for success. If managers are to have any chance for profits, they must take risks.

"Crisis management is often what managers do when they fail to manage risk," said Madsen. "It is a search for ways to salvage a business that is having difficulty creating a positive cash flow. It is trying to 'turn around' a business which is unprofitable and experiencing decreases in equity."

Risky events should be sorted into categories. This makes it easier to study ways to deal with the probability and potential magnitude associated with the occurrence of each event.

Madsen presented a few examples:

Production Risk

Weather causes many of the production risks, but we need to identify specific weather events and how they affect yields and quality.

A crop variety may have a good yield potential but is subject to leaf or stem rust.

Applying nitrogen to barley will increase yields, but may reduce chances of meeting malting quality.

Eliminating a pre-plant incorporated herbicide may increase risk of certain weed problems.

Elimination of insecticide may increase the probability of insect damage to the crop.

Use of corn-borer resistant corn variety will increase the seeding cost, but decrease the probability of damage due to corn borer infestations.

Crop insurance can compensate the insured for losses when low yields occur.

The probability of success can be improved, by choosing crops or livestock, which are not affected by the same events.

Financial Risk

Changes in interest rates can certainly occur. Borrowers can acquire longer-term loans with fixed interest rates.

Maintaining financial reserves to assure availability of credit.

Legal Risk

Production contracts with "Act of God" clauses can protect the producer against penalties when the commodity cannot be delivered due to adverse weather conditions.

Tax filing requirements.

Use of wills or other documents to enable the business to survive.

Use of corporations, partnerships or contracts to obtain credit and to protect the equity of the investors.

Use of written contracts to avoid misunderstandings.

Marketing Risk

Forward pricing or futures contracts can be used to protect favorable prices.

Human Risk

Life insurance can be used to protect the business when a key employee or investor dies.

Disability insurance can provide protection when a key person becomes disabled.

There are political risks that could fit under several of the listed categories. Labor laws could be a human risk, legal risk or financial risk.

Environmental risks could be associated with production, legal or human. We are also hearing more about food safety.

Madsen said producers can ask themselves several questions to help them evaluate their risk management:

* What is my risk tolerance?

* Have I communicated my tolerance for risk to the professionals who provide me with risk management services?

* Have I identified risks that can keep me from attaining my goals?

* Have I identified risks that I am comfortable retaining and managing with my own resources?

* Have I identified risks that I will shift to others?

* Have I identified risks that I will avoid?

* Have I identified the benefits I am attaining by buying certain insurance?

* What skills can I attain to better manage risks?

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