Risk is an important aspect of the farm business. Risk management involves choosing among alternatives that reduce the adverse financial effects of the uncertainties of weather, yields, prices, government policies, global markets, and other factors that can cause wide swings in farm income.
Risk is the probability of a known factor that has a certain potential to negatively affect a desired outcome, such as an accident, death, weather event, etc. Uncertainty is not knowing what will happen in the future.
The greater the uncertainty, the greater the risk.
The more likely a negative factor will occur, the greater the risk potential.
For a grain farm, risk management involves optimizing expected returns subject to the risks involved and risk tolerance. Farmers make decisions in a risky environment every day. The consequences of these decisions are generally not known when the decisions are made. Also, the outcomes may be better or worse than expected.
Components of Risk
The flowchart below shows the components of risk. Risk begins with an event, that may be external or internal. An outcome is a consequence, result, or impact of some event. Probability is the likelihood that any outcome will occur.
Click on the plus signs in the flowchart to learn about each component in detail.
Sources of Risk
There are five primary sources of farm business risk: Production, Financial, Legal, Human, and Price or Market. The first step in the process of managing risk is identifying and classifying prospective sources of risk to your farm business.
Click on the risk below to learn about each in detail.
Summary
Risk exists any time there is the potential for undesirable outcomes because presumably there are some outcomes that are less desirable than others. The chance of those less desirable outcomes occurring is the risk a farmer may face.
The more is known and understood about how to identify risks, the better a farmer can be at managing long-term risk.
While the right decision isn’t always possible, the likelihood of making smart decisions will improve the more we understand all the potential outcomes that could occur, the probability of each outcome occurring, and/or the cost of negative outcomes.
References:
Crane, L., Gantz,G., Isaacs, S., Jose, D. , & Sharp. R. (2013). Introduction to Risk Management. Understanding Agriculture Risk: Production, Marketing, Financial, Legal, Human Resources (2nd ed.). United States Department of Agriculture (USDA), Extension Risk Management Education and Risk Management Agency.
Harwood, J., Heifner,R., Coble, K., Perry, J., & Somwaru, A. (1999). Managing Risk in Farming: Concepts, Research, and Analysis, Agricultural Economic Report No. 774. USDA, Economic Research Service,Market and Trade Economics Division and Resource Economics Division.
Reddy, R., Andrews, G., Feuerstein, M., Fortenberry, R., Glewen, M., Hanson, M., & Vanderlin, J. (2004). AgVentures – Grain Marketing Module. University of Wisconsin – Extension.
This material was developed by the University of Wisconsin–Madison Division of Extension in cooperation with the U.S. Department of Agriculture and Wisconsin counties. This material is based upon work supported by USDA/NIFA under Award Number 2021-70027-34694.
