Risk Management Strategies
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
- 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
- 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
readings page for reports and articles related to risk