Financial risk has three basic components: 1) the cost and availability of debt capital, 2) the ability to meet cash flow need in a timely manner, and 3) the ability to maintain and grow equity. Cash flow are especially important because of repayments and family living expenses. Your objective should be to manage this risk through sound planning and financial control. To do that, you should continually monitor your ability to bear financial risk.

Farm Records and Analysis
: A set of well-maintained financial records is an absolute necessity to maintaining financial control of a farm or ranch. The flow of information is critical in evaluating past performance and in planning for future accomplishments.

Financial risk management is not achieved directly by maintaining comprehensive records. However, records do provide much of the information needed to understand critical financial risks.

Essential financial statements include the balance sheet and statement of owner's equity, income statement, and projected and actual cash flows. These records provide a history of your business and the data you need to calculate financial performance measures. Even small Farms need a basic level of record keeping.

As the size and complexity of an operation grow, so does the need for financial records. Ratios such as debt-to asset, debt-to - equity, and asset turnover are important in monitoring over financial performance. Other measures can be use to monitor the financial status of the business and provide guidelines for future decisions. These examine liquidity, solvency, profitability, financial efficiency and repayment capacity of the business

Interest Rate Risk:
Investment decisions are based on assumptions about future borrowing costs or the opportunity cost of invested funds. Borrowed capital can be a reasonable expense, especially if you are prudent in the financial leveraging of your farm business. After all, few operations are in a position to use only equity capital for new investments. Borrowing is a vital part of most farming businesses. Interest rate risk is mostly out of your control. However, you can sometimes influence your interest rate by lowering your debt-to - asset ratio and through the use of crop insurance coupled with a sound marketing plan. These actions by you reduce a lender's risk exposure.

Liquidity and Meeting Cash Flow Requirements:
Ensuring liquidity and adequate cash flow is the same as ensuring the farm's ability to survive shortfalls in net income relative to various cash obligations. Asset classifield as current on the balance sheet are assets that can be converted into cash within one operating cycle of the farm business, usually 12 months. Liquid asset include instruments that yield cash directly or that can be converted quickly to cash. Liquid assets include cash on hand, supplies, and crops and livestock to be sold within the year. Adequate liquidity is essential to ensure a sufficient cash flow. Also, adequate liquid reserves can facilitate contingency plans for production disasters or market conditions. However, excess liquidity typically generates lower rates of return than fixed assets. Timing is critical for ensuring adequate cash flows. With proper planning of expenses, cash flow needs can be known with reasonable certainty. This allows you to plan marketing decisions in advance and to take advantage of attractive pricing opportunities. Improving liquidity to ensure adequate cash flows can include reducing family living expenditures, using resources efficiently, leasing assets, and utilizing appropriate insurance programs.

Insurance:
There is a lot more to risk management than buying insurance. But, insurance can complement many other risk management tools. Knowing these interactions in risk can help you get more valve from your insurance dollar.

Family Living Costs: A significant component of financial risk is controlling and meeting family living costs. Re-ducing family living costs may not be feasible. But careful scrutiny of your living cost should be an integral part of annual cash flow planning.

In certain instances, off-farm employment can be a risk management strategy. It can ensure that living costs are met and can increase the family's standard of living. It may reduce the need of liquidate farm assets to meet family living needs.

(Source: Introduction to Risk Management: Understanding Agricultural Risk: Production Marketing, Financial, Legal and Human Resources. USDA, Risk Management Agency. 1997)