Farmers have many options for managing the risks they face, and
most producers use a combination of strategies and tools. Some strategies
deal with only one kind of risk, while others address multiple risks.
Following are some of the more widely used strategies.
- Enterprise diversification assumes incomes from different
crops and livestock activities do not move up and down in perfect
correlation, so that low income from some activities would likely
be offset by higher income from others.
- Financial leverage refers to the use of borrowed funds
to help finance the farm business. Higher levels of debt, relative
to net worth, are generally considered riskier. The optimal amount
of leverage depends on several factors, including farm profitability,
the cost of credit, tolerance for risk, and the degree of uncertainty
in income.
- Vertical integration generally decreases risk associated
with the quantity and quality of inputs or outputs because the
vertically integrated firm retains ownership or control of a commodity
across two or more phases of production and/or marketing.
- Contracting can reduce risk by guaranteeing prices, market
outlets, or other terms of exchange in advance. Contracts that
set price, quality, and amount of product to be delivered are
called marketing contracts, or simply forward contracts. Contracts
that prescribe production processes to be used and/or specify
who provides inputs are called production contracts.
- Hedging uses futures or options contracts to reduce the
risk of adverse price changes prior to an anticipated cash sale
or purchase of a commodity.
- Liquidity refers to the farmer's ability to generate
cash quickly and efficiently in order to meet financial obligations.
Liquidity can be enhanced by holding cash, stored commodities,
or other assets that can be converted to cash on short notice
without incurring a major loss.
- Crop yield insurance pays indemnities to producers when
yields fall below the producer's insured yield level. Coverage
may be provided through private hail insurance or federally subsidized
multiple peril crop insurance.
- Crop revenue insurance pays indemnities to farmers based
on gross revenue shortfalls instead of just yield or price shortfalls.
Several federally subsidized revenue insurance plans are available
for major crops in most areas of the United States.
- Household off-farm employment or investment can provide
a more certain income stream to the farm household to supplement
income from the farming operation.
Most producers use a variety of farm management strategies and
tools, and since risks and the willingness and ability to bear risks
differ from farm to farm, so do the risk management strategies used.
See the recommended readings
page for reports and articles related to risk management.
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