Issue No 11, January 1999.

NOTICE: Hard copies of the Australian New Crops Newsletter are available from the publisher, Dr Rob Fletcher. Details of availability are included in the Advice on Publications Available.

4. Will your new venture pay?

[Most of these remarks have been extracted from a Plenary Address given by Barry D Buffier, National Manager, Agribusiness, Westpac Banking Corporation at the Emerging Opportunities in Agriculture Information Day at Tamworth, October 9, 1998.

The Workbook is published by the Westpac Banking Corporation (1996)]

Risk is defined as exposure to the chance of injury or loss.

Business challenges vary in their chances of producing a financial loss or gain.

New crop industries are usually considered higher risk enterprises than conventional crop farming because the future trading (market), financial (economic), physical (production) and social (personal and management) environments are more likely to be unknown and thus it is more difficult to generate the profit outcomes sought.

Risk management is the process of identifying, understanding, controlling and pricing the risks that are inherent in emerging crop opportunities in agriculture.

There is a risk involved with the adoption of any new variety of any conventional agricultural or horticultural crop.

This is because the levels of information and experience available are less than would be available with the previously well-used variety.

Similarly, risks are likely to increase step-wise with:

• the adoption of new technology, then with
• the commercialisation of entirely new crop products and finally
• to be highest with sunrise industries.

These increased risks arise because entirely new value-chains from producer to consumer have to be developed. Both production and product are untried and unknown with most new crop industries.

The likely level of risk can be predicted from the joint consideration of the likelihood of an event occurring and the impact the event is likely to have on the fortunes of the new crop industry concerned, as shown in the following diagram (Buffier, 1998):

Risk management is about understanding where a business fits on this matrix, ensuring that there is an acceptable risk:reward ratio or undertaking strategies that will move the business to a position where the risk is lower, relative to the reward.

The health of an agricultural enterprise can be gauged from the level of equity and the nature of the cash flow, as shown in the following diagram (Buffier, 1998):

For broadacre conventional rural properties, a low equity level would be less than 50%, medium would be 50-70% and a high level would be over 70%.

The following could be used as risk management strategies:

• The most important first step with risk management is to differentiate between:
• Minimising the impact of those risks that cannot be controlled and
• Controlling those risks that can be managed.
• Maintaining a high level of equity
• Increasing productivity
• Accurately monitoring the farm budget
• Maintaining some liquid assets
• Ensuring access to the best information as it becomes available
• Preparing fall-back strategies and contemplate options in case of disaster
• Continually monitoring levels and trends in those developments that determine risk
• Investing in enterprises or assets off the farm or maintaining off farm employment
• Diversifying into new crop (or animal) ventures or increasing the farm size, usually through borrowing.

When a lending agency considers whether to use debt or equity financing, it is likely to consider the following:

• Customers margins applied to borrowings usually range from 1-3%
• Banks will lend for new ventures if the existing cash flow will support the new venture
• the new venture represents acceptable risk and the assets ensure a 'fall-back' position
• It is sometimes possible to shift some of the risk by forming alliances along the value chain from producer to consumer
• If the venture is high risk then the risk/reward ratio must be higher
• A high risk/reward ratio generally relies on equity financing, which genrally involves giving up some level of control over the operation. Major banks have not been big players in the equity financing market, but many boutique financing operations are involved, often with a minority shareholding
• Public listing is not relevant for most new crop industries because they are small scale
• Trade-offs are possible with level of control, price and risk so many different forms of arrangements between the partners can occur.

1. Do a risk audit or develop a risk profile (as described in the next article)
2. Develop a business plan with goals, objectives, budgets and cash flows
3. Use financial modelling of cash flows to examine the impact of different events occurring
4. Calculate the profitability using appropriate measures such as NPV (Net Present Value) and IRR (Internal Rate of Return)
5. Look at the risk/reward ratio relative to the level of risk that is acceptable
6. Understand the 'full-back position' if the venture fails.

Contact: Dr Rob Fletcher, School of Land and Food, The University of Queensland Gatton College, 4345; Telephone: 07 5460 1311 or 07 5460 1301; Facsimile: 07 5460 1112; International facsimile: 61 7 5460 1112; Email: r.fletcher@mailbox.uq.edu.au

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originally created by: GK; latest update 6 June 1999 by: RF