Managing your financial risk
If you wrote down all the unexpected things that could cause you to not meet your financial projections, it would be a long list. Any changes in weather, commodity prices, input costs or interest rates can impact the way you do business. In addition to these, is your tolerance for risk.
Everyone has a different comfort level with risk. And it often changes depending on your age, business stage or family situation. And it even varies between members of your family farm. If you’re near retirement, you may have a different risk appetite, compared if you’re younger and ready to grow the operation.
While the future is uncertain, you should always consider the risks facing your business, any implications and what mitigation options are available to you.
Conduct a sensitivity analysis
Sensitivity analysis is a useful tool for gauging financial risk. You can run scenarios on how the business would be affected by higher interest rates, a drop in revenue, higher than anticipated input costs or a combination of these factors. Understanding your financial situation is a good starting point to build resilience and makes it easier to prioritize the biggest threats to your business. An analysis will also help you select the best strategies to address possible risks.
To shelter your operation from risks, start with things you can control like:
- Locking in borrowing costs with a fixed interest rate
- Staggering your loan renewal dates
- Using the futures market or contracts to lock in prices
- Pre-purchasing inputs to guard against price increases
Government insurance programs
Agriculture and Agri-Food Canada funds a suite of business risk management programs for farmers including, AgriInvest, AgriStability and AgriInsurance. Here are the program basics and how they might fit into your risk management plan.
With AgriInvest, you can deposit 1% of your eligible net sales each year and receive a matching government contribution. You can withdraw funds at any time, but it comes first from government contributions and any earned interest and is included as income for tax purposes. Supply managed commodities are ineligible for AgriInvest.
While AgriInvest helps you manage small margin declines, AgriStability provides support for significant margin declines. Enrolled producers receive a payment when their current year program margin falls below 70% of their reference margin. Payment is 70% of the margin shortfall.
Margins are based on revenue minus eligible expenses. Your reference margin is your average program margin for the past five years, with the lowest and highest margin years dropped from the calculation. Your reference margin will be limited to the lower of your historical margin or your average allowable expenses for the years used.
AgriStability will change in 2020 so that payments received from private insurance programs will no longer offset AgriStability support. Previously, proceeds received from private hail insurance, the Western Livestock Price Insurance Program, Global Ag Risk Solutions and others counted as income and correspondingly reduced AgriStability payouts.
However, payments from government-supported AgriInsurance or crop insurance programs will continue to offset AgriStability payments since these programs all receive substantial government funding.
Producers who don’t use crop insurance may have their AgriStability benefit reduced. This reduction occurs only if the producer has a negative program year margin. Still, it’s a reason to keep crop insurance and not assume that AgriStability will cover all your production risk.
AgriInsurance (crop insurance), is production insurance. Because it’s administered provincially, each program and its available options and eligible crops differ. There may be coverage options you haven’t explored, so review program details thoroughly. Premiums and coverage levels are adjusted each year, and new coverage options are implemented. Watch for announcements and the deadlines to implement changes in your policy. These typically occur before the growing season.
Not all producers enrol in crop insurance. Some prefer to take the risk of a production shortfall and save the premium cost. Your appetite for risk and your overall financial situation factor into your insurance decisions, but it’s best to base decisions on analysis rather than gut instinct.
Private insurance programs
The Western Livestock Price Insurance Program (WLPIP) s fund the insurance.
WLPIP protects enrolled producers against unexpected price drops for cattle and hogs on a defined period, and there are separate programs for calves, feeder cattle and fed cattle. The program provides a floor price based on the changing market outlook and a forecasted price for a set marketing period. The higher your established floor price, the higher the premium.
For cow-calf producers, coverage can be purchased from early February to the end of May. To establish a floor price for intended marketing during the fall calf run, it’s from September to December. The program doesn’t require a producer to sell calves in the fall. Coverage is based on the prevailing market prices as compared to the floor price you’ve locked in for a specific time.
Since the program is based on forecasted market prices, the floor prices offered could provide a profit in your operation. However, the program does protect you if market prices drop lower than expected for any reason or combination of reasons.
In Western Canada, crop damage from hailstorms is a significant risk, and many producers buy hail insurance. Alberta and Manitoba offer spot loss hail insurance as part of their crop insurance portfolio. Insurance rates vary from one area to the next based on the historical risk of hail damage. Rates also vary by crop type since some crops are more prone to hail damage.
While AgriInsurance provides yield coverage for each crop, hail damage is often sporadic. You may suffer losses in some fields and not others, particularly if your land spreads out. So, even if you were hit by hail, your average crop yield might still be above the crop insurance guarantee negating a payout. That’s why many producers carry both hail and crop insurance.
Private revenue insurance
In recent years, private revenue insurance has been available for crop producers in some regions of the country, the most notable being Global Ag Risk Solutions. The program covers your seed, fertilizer and chemical costs, plus a chosen margin above those costs. Different kinds of coverage are available, but it’s not crop-by-crop coverage like that offered under crop insurance programs. Past accrual financial records determine coverage and premiums for each farm.
Now that you know some of the risk management options available to you, here’s how you can put them in action.
- Discuss financial risks with your management team, accountant, advisor and lender
- Perform a sensitivity analysis to determine your risk health
- Understand and use support programs that make sense for your operation