Nikhil, a startup founder, was on cloud nine as his startup had just received fresh funding. While celebrating with his friends, they cautioned him about having a financial contingency plan. He was curious and asked his friend Kunal to explain to him what needed to be done, which he did.
What is Financial Contingency Planning?
Contingency planning is an action plan of the process that would be followed in the face of an extraordinary threat. A step-by-step plan will be executed and a plan to back up the original plan, should the original plan fail.
So financial contingency planning is a subset of this and focuses on the business’s financial health to ensure continuity and solvency.
What is a Financial Contingency Plan?
A Financial Contingency Plan identifies all the worst-case scenarios, their impact on finances and the resources available to combat them to ensure business continuity. Nikhil acknowledged that it is good to have a coping mechanism, but Kunal burst the bubble and said there is more to it.
Why are Financial Contingency Plans so important?
A financial contingency plan gives the business resilience to jump back; this trait has become a strong parameter of a company's reliability post the pandemic. It lays a strong foundation for mitigating risk and speedy recovery. Kunal asked Nikhil if he would travel in a plane with all safety measures in case of a disaster or in one without it. Nikhil said, obviously the one with it. Kunal said that's exactly how stakeholders feel about a business with a contingency plan. While a disaster cannot be predicted, they feel secure about a safe landing.
Benefits of a Financial Contingency Plan
Nikhil now understood that the benefits of the financial contingency plan are staying solvent and maintaining ‘Business as Usual’ post a contingency. However, Kunal emphasized that there are more benefits, as detailed below:
● Reduced stress and panic in the face of crisis
● A better reputation, as a mechanism, is in place to respond to a crisis effectively
● Quicker execution by the team as roles and actions plan is defined
● The tested plan ensures adaptability to different scenarios in the future
Nikhil was now eager to understand how to create this plan, to which Kunal happily obliged and explained the steps involved in creating one.
How to create a Financial Contingency Plan?
Creating a financial contingency plan is a methodical step-by-step process, as detailed below:
1. Identify the risk. So identify a few risks, say 5-6, that can jeopardise business operations. Now, these need to be assessed in terms of likelihood, severity and impact.
2. Analyse the triggers of these risks. An understanding of what could cause these risks and documenting them can help.
3. Break down the triggers into signs that could lead to trouble and devise a plan to face them. This will ensure that you stay ahead of time.
4. Define actions to be taken, who will take them and the stipulated time frame.
5. Look at the financial profile in detail. Use every financial planning and analysis tool to understand business operations, costs, markets, competition and cash flow.
6. At this point, ask yourself all the relevant yet difficult questions. What is my cash reserve? What are the assets I can dispose of if need be? Which assets must not be touched? Which business unit can be shut down? What costs can be cut down? What is the loan I could avail of if need be? Do I have any insurance that can cover costs?
7. When these difficult questions are answered, you will know what to do in times of crisis, like dipping into reserves, using lines of credit with a bank, scaling down production, or selling a non-core business unit. You will also know what will work given the short time frame to respond to a crisis. And what resources can be used second in line to bring the business back on track.
While having a plan is great, what is equally important is knowing when to activate the plan, who will activate it and reviewing it to ensure it is updated and in line with the current scenario, concluded Kunal.
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