Risk Management Planning Guide
In today’s global agricultural economy, risks to producers, processors and marketers are expanding and surfacing in many ways – exposing all to more unfavorable circumstances and increasing uncertainty. Finding ways to manage risk and exposure given increasing uncertainties is critical for long-term business success. Developing a risk management plan helps business owners anticipate and mitigate risks.
The following guidelines provide basic steps for developing a risk management plan. Ultimately, the plan’s details and execution depend on your industry and unique circumstances. The steps below can help you get started and are each outlined in the following sections:
Steps in Risk Management Planning:
- Define Success: Identify business goals and objectives
- Identify Risks: Conduct a SWOT analysis
- Assess Risks: Complete a risk assessment and identify available tools
- Manage Margins: Understand costs, breakeven and sensitivity
- Drive Performance: Execute, follow-through and evaluate
Risk Categories and Tools
Risk management is a broad term and the risks facing each business vary. While every operation is unique, risks for agricultural operations generally fall into several categories. Consider each category as you identify risks specific to your business. Identifying and planning for these risks is key in the risk management process.
Risk Management Planning Steps
Managing risk should be a priority for every operation, but is most important for businesses in volatile markets and/or with elevated debt levels where small shifts in markets or margins may cause crippling losses in a short period of time.
The following steps can help you develop a risk management plan.
Step 1: Define Success: Identify business goals and objectives
Developing a risk management plan without first identifying business goals and objectives is like planning a trip with no destination in mind. Meet with your ownership, management and key players to define success and agreed-upon milestones along the way. With goals and objectives in place, prioritizing risks and risk tools will be much easier. Simply identify those risks that pose the greatest threat to your shared vision for the future.
Step 2: Identify Risks: Conduct a SWOT analysis
A SWOT analysis is an evaluation of the operations’ Strengths, Weaknesses, Opportunities and Threats. This fundamental tool for strategic and risk management planning can help the team identify risks and blind spots in the operation.
While many business owners have a “gut feel” for strengths and weaknesses of their operation, gathering input from others and formalizing findings is a key component of understanding risk exposure.
Strengths and weaknesses (internal and controllable) may include business planning, succession planning, financial management, human resource practices, core competencies, financial or operational positioning. Opportunities and threats (external and out of management control) may include adverse weather, government regulation, marketplace volatility, shifts in consumer demand or a publicized event in the industry. Monitoring opportunities and threats regularly assures that contingency plans can be implemented quickly when the landscape changes. Think about the best management practices used in your industry as you evaluate your operation’s strengths and weaknesses.
To begin, review each of the risk categories on page 2 and categorize your strengths, weaknesses, opportunities and threats in each category.
Step 3: Assess Risks: Complete a risk assessment and identify available tools
Using the SWOT analysis, you can now identify key threats to achieving your strategic goals and objectives. Completing a risk assessment helps to assure key players understand risks facing the operation and helps prioritize tools and options to mitigate risks.
Risk Assessment Process
The following section outlines one approach to assessing risk. Whatever process you use, it should help you to identify, prioritize and assess options to address the risks facing your operation. This process prioritizes risks based on the likelihood that some risk event will occur, and the operational or financial impact if it does occur. Using your SWOT, create a spreadsheet or document with the following columns:
Column A - Risk Event: Using the SWOT, list the key risks facing your operation
Column B - Probability Rating: Assign a rating based on the probability that risk events will happen within the next three years. Use the following table to assign ratings:
Column C - Impact Rating: Assign a rating based on the potential impact to your goals, objectives and/or profitability. Use the following table to assign ratings:
Column D - Total Risk Score: Calculate the total score for each risk by adding the Probability (Column B) and Impact (Column C) Ratings. Assess the calculated total relative to other risks and using the table below:
Column E - Strategy: List options for addressing the identified risk.
Step 4: Manage Margins: Understand costs, breakeven and sensitivity
Volatile commodity markets and the competitive global landscape mean managing profit margins is more difficult and more important than ever before. Knowing your operation’s break even costs on a crop-by-crop or product-by-product basis is critical to business success, and without this information, risk management tools – especially marketing strategies – can be ineffective.
Know Your Costs: To know your breakeven, you have to know your costs. This means having a financial management system to track inputs and processes to ensure you’re capturing operational data and information accurately. It also means distinguishing between fixed versus variable costs and allocating costs appropriately among enterprises:
Know Your Breakeven: Once your team understands its costs, you can calculate the breakeven point. There are many ways to calculate breakeven and even different types of breakeven calculations, but the most effective measures include the following items over a specified period:
- Average sales price for each commodity or product
- Assignment of fixed and variable costs to each commodity or enterprise
- Production volume (especially important for any processing / packaging operations)
After you establish the items above (historical or projected), you can complete a breakeven analysis that is meaningful for your operation:
Assess Balance Sheet Risk: The key to managing margins is to know your breakeven points and how much risk your balance sheet can handle.
For production agriculture operations, two key measures of the balance sheet’s short-term risk bearing capacity include working capital and working capital as a percentage of annual expenses. These measures indicate how much of the operation’s expenses can be funded with owner’s equity in the coming year (approximately) versus other sources of cash. The safe or target level is different for each business and commodity, and is influenced by the amount of production and price risk the operation is subject to. If you’re unsure about balance sheet risk, ask your Northwest FCS’ relationship manager or refer to the Understanding Key Financial Ratios and Benchmarks Business Tool.
Establish Price Trigger: Sales prices and costs may or may not move together. To manage risk effectively, decision-makers need to consider sales prices and costs simultaneously when making pricing decisions. One way to think about managing margins is to establish a “market playing field” to operate within from a price perspective
After you understand your balance sheet risk, clearly identify your overall appetite for risk and set an acceptable price target range based on your breakeven calculations. With the pricing targets identified, you can evaluate using risk management tools like forward contracts and hedges on both revenue and input costs, enabling you to know when to ‘pull the trigger.’
Managers who use margin management acknowledge they ‘leave some earnings on the table’ in up markets. They also sleep better at night knowing they’ve locked in solid profit margins during times of volatility, knowing they’re protecting the balance sheet (and hard-earned net worth) from extreme market shocks. A systematic approach to marketing products and purchasing key inputs over the course of the year generally results in better business results over time and improves planning and communication.
Understand Before You Buy: Tools for managing market price and input costs include cash markets, forward contracts, futures contracts, options and mixed strategies. If you do not fully understand the options, get help from someone who does, especially when considering futures or options to hedge price risk. Using these tools haphazardly is closer to speculation than risk management. Contact your local Northwest FCS representative for a list of risk management resources
When using leverage (credit) to fund your strategy, follow your risk management plan consistently and avoid speculation. Execute risk management tools based on your plan and not emotion
Step 5: Develop short-and long-term goals and action plans
The previous steps help you identify, prioritize and develop plans to manage your operation’s risks. Use your analysis to develop short-term goals (less than one year) and long-term goals (more than a year) for managing risks in your operation. Goals should be SMART – specific, measurable, attainable, realistic and time-based.
After identifying your goals, create an action plan for each goal. Action plans should identify who is ultimately responsible for achieving the goal, steps needed to accomplish the objective, who is responsible for each step and target dates for progress at each step.
Review goals and action plans periodically to ensure you’re making progress. Keep in mind, you many need to adjust some goals to adapt to opportunities or threats that develop in the marketplace.
Action Plan Sample:
Risk Management as a Discipline
There is no single tool, strategy or silver bullet for managing risk. Rather, risk management is a comprehensive process and represents multiple tools and strategies. The ultimate goal is not to eliminate risk, but to manage it effectively through a comprehensive process. Market volatility reminds all of us in agriculture that what may seem like a positive on the surface can have dramatic impacts on other aspects of our business. Increased time and attention toward risk management planning will go a long way in positioning your business for long-term success.