An Introduction to Risk
Risk is and always will be an inherent part of agriculture. Understanding basic risk management concepts and principles is critical to thinking through the many decisions you make on a daily basis.
Risk Tolerance vs. Appetite
Risk tolerance and risk appetite are terms often used interchangeably for describing a farm operator’s willingness to take on various levels of risk. However, the terms have some key differences.
Risk appetite is strategic and provides a measure of the highest level of risk you are willing to take on as you pursue value. It provides insights into questions, such as:
- What risks do we seek to take and why?
- What risks do we want to avoid and why?
- Are there risks we can manage better than our competitors? If so, what are they?
- Are there uncertainties inherent in our business model that we need to understand?
- What risks inherent in our business model need to be reduced to an acceptable level and over what period of time?
- What future developments or emerging risks could alter the assumptions underlying our strategy?
- How do we want to do business?
Risk appetite gives farm decision maker a way to discuss which risks are acceptable and, thus, can be a useful tool for evaluating growth opportunities. Steps to identify risk appetite:
- Develop a risk appetite statement, or a summary of observations that frame your appetite for risk. A good place to start might be to look back over the risks your farm has taken on in the past and identify those you have accepted or avoided based on certain conditions or within specified ranges of exposure. This list should consist of both:
- Risks that are acceptable to you or your business because there is sufficient reward for taking on risk. An example might be the decision to expand production capacity or to enter a new market.
- Risks that are undesirable and should be avoided at all costs (including situations that could negatively impact your reputation).
- Define strategic, financial and business parameters. These might include enterprises to enter or exit, net farm income target, planted acres, etc.
Risk tolerance is tactical, and can form specific boundaries within your overall risk appetite. The one question it should address is:
How much variability are you willing to accept as you pursue a specific business objective?
This question is important as you assess your exposure to downside risks while seeking upside performance.
Risk tolerance can serve as an effective tool when pursuing growth opportunities or evaluating certain enterprises. It may be expressed differently for varying objectives, including those related to revenues, interest rate exposure, regulatory compliance and managing employees.
Summary
While identifying your risk appetite might seem like a new concept, keep in mind that this is probably something you already practice through your actions or inactions. Let it serve as a reminder of your original core risk strategy. Remember that your risk appetite should be flexible enough to respond to changes in the market or environment.