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Assessing Your Farm's Risk Bearing Capacity: The Foundation of Effective Risk Management Presentation

Public & Private Partnership Understanding Agriculture's Risk
Funded by: USDA Risk Management Education Initiative
Cooperative State Research Education and Extension Service
USDA Risk Management Agency
Commodity Futures Trading Commission
USDA Office of Outreach

Learning materials and decision tools for Agricultural Risk Management:
Managing Financial, Production, and Price Risk.

"Available to Download"

Chapter 2

Table of Contents

1. Instructor Guildlines

2. Introduction

3. Basic Risk Management Tasks

4. Task 1: Analyzing your Farm's Risk Bearing Capacity

5. Task 2: Analyzing your Farm's Sources of Risk

6. Task 3: Familiarizing yourself with Risk Management Tools and Strategies

7. Task 4: Select and Implement Risk Management Plan

8. References

9. Appendix: Exercise in Financial Statement Preparation and Analysis

The objective of this chapter, Assessing Your Farm’s Risk-Bearing Capacity: The Foundation of Effective Risk Management, is to provide agricultural producers with the practical analytical tools and standards they can use to measure how financially vulnerable their farm or ranch business is to the many sources of risk. Once this assessment is completed, the producer can determine which marketing, crop insurance, or other risk management tools to use. It is only after making these assessments that a meaningful risk management plan can be developed.

This chapter starts with a discussion of farm financial risk and why it may not all be bad. The chapter outlines the four basic tasks of effective risk management and demonstrates, using the financial statements from the Case Farm presented later in this curriculum, how to determine the risk bearing capacity of the farm. The step by step process presented in this chapter provides a practical guide that can be used by any producer to assess their own firm’s risk bearing capacity given that they have the financial statements that are available to every farm with an adequate set of financial records.

Preparation for using this chapter should include a thorough review of the Chapter 8: Case Farm. That chapter contains a complete set of financial records for a PNW small grains operation. Information from the Case Farms Chapter is used in the examples in this chapter as well as for the other chapters in this curriculum.

The balance sheet is explained in some detail because of all the information it contains about the health of the farm business and the financial changes over time experienced by the farm business. Clear examples of how to use income statements with the balance sheet in business planning are explained.

The basic measures of financial strength—liquidity, solvency, profitability, repayment capacity, and financial efficiency—are developed in some detail with explanations on how to interpret and use the information provided by these ratios. These measures of financial health are very powerful tools for the individual farm business manager. These measures of financial health can be used to determine the present financial health of the farm business. They are used to develop the business plan including which risk management tools are required and at what level to apply them for future business success. Charting them over time presents an excellent trend analysis of the farm business. The process of calculating these measures is clearly presented and is not difficult to learn or master. Each can be calculatedusing the information provided in the commonly used set of farm financial records. Industry standards are provided so that the individual farm operator has some basis for comparison in how the firm is doing.

How to Use this Chapter

The information in this Chapter is covered on the power point presentation, Assessing Your Farm’s Risk Bearing Capacity: The Foundation of Effective Risk Management which is included on the CD-ROM. The power point presentation integrates information from the Cost of Production chapter and the Managing Your Farm’s Financial Risk chapter so does not follow the outline of this chapter directly. It can be presented in about an hour although there is sufficient information here to provide material for several sessions. This chapter can also be used as a stand alone curriculum, using the information provided here to provide a workshop outline, create overheads, participant exercises, and take home materials. It would provide a foundation for a more in depth course in which producers as home work, substituted their own financial information for the Case Farm statements.