An Introduction to Risk

Risk is—and always will be—an inherent part of agriculture. Having an understanding of basic risk management concepts and principles is critical in order to think through the many decisions you’ll need to make on a day-to-day basis. An Introduction to Risk

Risk Tolerance vs. Appetite

Risk tolerance and risk appetite are two terms often used interchangeably for describing a farm manager or operator’s willingness to take on various levels of risk. You’ll see, however, that there are key differences between the two.

RISK APPETITE

Risk appetite is strategic and provides a measure of the highest level of risk you are willing to accept in pursuit of value. It provides insight 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 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?

By giving decision makers in the business a way to discuss which risks the organization considers acceptable, risk appetite can be a useful tool for evaluating growth opportunities. Below are some steps you can take to identify your risk appetite:

  1. Construct 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 business 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:
    1. 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.
    2. Risks that are undesirable and should be avoided at all costs (including situations that could negatively impact your reputation.)
  2. Define strategic, financial and business parameters. These might include enterprises to enter or exit, net farm income target, planted acres, etc.

RISK TOLERANCE

Risk tolerance, on the other hand, is tactical, and can form specific boundaries within the overall risk appetite you choose to pursue.

The one question risk tolerance 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, compliance with regulations and managing employees.

SUMMARY

While identifying your risk appetite may seem like a new concept, keep in mind that this is probably something you already have and practice through your actions or inactions. Let it serve as a reminder of your original core risk strategy—and remember that your risk appetite should be flexible enough to respond to changes in the market or environment.

Protiviti, “Defining Risk Appetite.” Early Mover Series: Integrating Corporate Performance Management and Risk Management | Submitted by Elizabeth Yeager