A Nebraska farm with $1,000,000 in yearly revenue from five lines has to decide how much cash to hold for a bad year. Sized on the largest line, a 30 percent loss on $400,000 of corn asks for $120,000. Sized on the lines that fail in the same year, corn and soybeans together bring in $650,000, and the same loss asks for $195,000, so the first method leaves the reserve $75,000 short. Size the reserve on the effective number of sources: how many sources of equal size would split your money the way it is actually split. First add the sources that share a cause into one group. To find the number, split last year’s revenue by source.
How do five lines of revenue become one number?
Take each line’s share, which is its revenue divided by the year’s total. Square each share, add the squares, and divide one by the sum. The result is the effective number of sources.
The example farm is in Nebraska, and its figures are invented for this page. Corn and soybeans go to one grain elevator, the local company that buys, stores and ships grain. Cattle are finished in a nearby feedlot, the hay is sold to feedlots, and one neighbor rents the pasture.
| Source | Revenue | Share | Share squared |
|---|---|---|---|
| Corn | $400,000 | 0.40 | 0.1600 |
| Soybeans | $250,000 | 0.25 | 0.0625 |
| Finished cattle | $200,000 | 0.20 | 0.0400 |
| Hay | $90,000 | 0.09 | 0.0081 |
| Pasture rent | $60,000 | 0.06 | 0.0036 |
| Total | $1,000,000 | 1.00 | 0.2742 |
Five sources of $200,000 each would give 5, and a single source would give 1, so 3.65 means the farm leans like three and a half sources of equal size. The sum of the squares is also called the Herfindahl-Hirschman index. One minus that sum, 0.73 here, is the diversification index, also called the Simpson index. It runs from 0 for a single source toward 1 for many equal ones.
Squaring gives the big lines their weight. Corn at 0.40 adds 0.16 and pasture rent at 0.06 adds 0.0036: the corn line earns 6.7 times as much and counts 44 times as much. A small line barely moves the result, which is how a measure of dependence should behave.
Read the count first, because equal steps on the index are not equal steps in sources. An index of 0.90 means 10 equal sources and 0.95 means 20, so a gap that looks like rounding on the scale from 0 to 1 doubles the count.
Split last year’s revenue by source and write each share beside it.
Is that number good or bad?
Use published bands as a rough guide. Ipea, the Brazilian government’s economic research institute, published a chapter that sorts areas by diversification index, with a classification adopted from Sambuichi and colleagues. Exactly 0 is a single product. Up to 0.35 is specialized, up to 0.65 is diversified, and above 0.65 is very diversified.
The chapter applied the classes to the municipalities of São Paulo state, and it notes that a single-crop farm is more likely to be found than a single-crop municipality. A single farm therefore tends to look more concentrated on these bands than a whole municipality does. Read the class as a hint, not as a verdict on your farm.
Each cut has a reason written beside it. The specialized class covers municipalities that, despite having more than one product, draw 80 percent or more of the gross production value from just one. Very diversified required at least three products of similar weight in that value.
The arithmetic agrees. One source with 80 percent of revenue adds 0.64 to the sum on its own. That puts the index between 0.32 and 0.36, depending on how the other 20 percent splits, and the 0.35 cut falls inside that range. Three equal sources give a sum of one third and an index of 0.667, just past the 0.65 cut.
The example farm, at 0.73, lands in the top class. A farm can sit there and still lean on about two sources, as the next section shows.
Find your own index on the bands and write the class beside it.
What if two sources have a bad year together?
The count above uses shares only, and shares carry no trace of which sources fail in the same year. The OECD, comparing farm accounts across countries, found that combining crops whose returns are not perfectly correlated lowers the swings in total revenue. Two sources that rise and fall together are one source with two names.
Where one drought hits every crop, that protection shrinks. In the same report, yield correlation between crops was higher in Australia, so one crop failing was more likely to come with another failing. Prices behave worse than yields: the OECD found that prices move together more than yields do. A second crop therefore protects you better against a bad harvest than against a bad market.
Group the sources that fail together. On the example farm, corn and soybeans share the same rain and the same elevator. Cattle and hay share another cause, because the feedlots that buy the hay follow the cattle market. Pasture rent stands alone. Counted that way, the farm has three groups, and the effective number falls from 3.65 to 1.96.
The revenue concentration calculator has a group column for this. Type the same short word, spelled the same way, for the sources that go together, such as “grain” or “cattle”. “Grain” and “grains” make two groups.
Check the groups against the books before you trust them. Write revenue by source for the last five to eight years, sources in rows and years in columns, and mark each year a source came in below its own average. Two sources marked in the same years belong in one group, whatever they are called. Fill in the group for every source or for none, because a source left blank counts as a group of its own, which assumes it is independent of everything else.
Give the same word to the sources that failed in the same years, redo the arithmetic and size the reserve on the largest group.
Does adding another activity fix it?
Adding an activity is the most expensive way to lower dependence, and it does not always work. A study of rural households in Zambia, using a nationally representative survey, found that crop diversification significantly improves income stability but significantly reduces technical efficiency, meaning less output for the inputs used. Those were rural households, not commercial farms, so read it as a direction and not as a size.
The Incaper paper on Espírito Santo, a Brazilian state, cites the view that specialization is not negative in itself and can come with productivity gains from comparative advantages. A concentrated farm is not a mistake. It is a choice whose cost you should be able to write in dollars.
Try the cheapest step that moves your largest group, in this order.
- A second buyer for a product you already sell. Check that the new buyer’s price does not follow the same market.
- A different payment month for money you already earn.
- An activity whose bad years differ from the group’s.
- Protection bought in place of an activity. In a simulation with farms in the United Kingdom and Australia, the OECD notes that affordable yield insurance can take the place of crop diversification, and less so where risk is systemic. Yield insurance does not cover price, so for price see the written selling plan.
A new activity pays back over several seasons, so test it first on paper with the three-year production plan.
Write, beside each candidate, the one event that would make it fail.
What goes on the sheet, and when do you redo it?
Start with last year’s bank statements and write beside every deposit where it came from. That step alone often turns up a line nobody counted as revenue. Then keep one dated page with the farm’s other planning records, listed in the farm planning articles. The calculator takes only a name, an amount and a group for each source, so the page holds seven things it cannot work out.
- The twelve months measured, and what will not repeat: a machine sold, an insurance payout, a late payment from the year before. Each makes one source look bigger or smaller than usual.
- One line per source with the buyer named. Not “grain” but the company that paid, which is where two sources with one buyer turn up.
- The month each source actually pays, by payment date and not by contract date.
- The last bad year of each group, and whether two groups share it. The cause you wrote is what you believe; the year is what happened.
- The largest buyer, added across sources. On farms that sell several products to one cooperative, it is often larger than the largest source.
- What the lines share besides price and weather: the same combine in the same three weeks, the same crew at the peak, the same collateral at the bank.
- A threshold for redoing the page, such as any group above 60 percent of revenue, a calendar date to redo it anyway, and the name of the person who keeps it.
The date matters because shares move without anyone deciding. In Espírito Santo, the Incaper paper’s diversification index, on a scale where a higher number means more diversified, fell from 9.12 in 2013 to 6.21 in 2022. Coffee went from 38.86 percent to 50.81 percent of the value of the state’s farm production, and the paper credits both more output and higher prices. A state is not a farm, but the drift is the same: a good price grows one line until the page no longer describes the farm.
Write each group’s cause in the farm’s risk list too; ranking that list is covered in the article on which farm risks come first. In the example, the grain group is 65 percent of revenue, and a cause that can hit that much in one year belongs at the top.
Write the page this month, with the date to redo it on the same sheet.
The same sheet, set beside the year that follows, serves every other line of farm management.