Financial Contingency Planning: What Do You Need to Consider?
In September 2021, there were 1,446 bankruptcies in the United Kingdom, a 56% increase compared to the same month in the previous year, highlighting the importance of having a back-up plan in case things go south.
Whether you are running an established small and medium-sized enterprise (SME), or you are in the early stages of forming your business, having a solid financial contingency plan is a must. Understandably, if you are just starting off with your new endeavour, you might not be necessarily thinking about developing your contingency plan — you’re all focused on growing your business.
Yet, unexpected events may derail your startup's plans, cause disruption of normal operations or even lead to insolvency. The good news is that all of this can be prevented with the help of a solid financial contingency plan.
Thus, in this article we will delve into the importance and benefits of having a financial contingency plan for your SME, and what aspects, as a business owner, you must consider in order to prepare for the worst scenario.
What is financial contingency planning?
In a nutshell, financial contingency planning is the process of creating a strategy for managing your company's overall risk, with a focus on resource and financial allocations to keep the business solvent and operational during a crisis.
Management or entrepreneurs often use predictive models in financial contingencies to mitigate risk, err on the cautious side, or anticipate somewhat 'worse-than-expected' outcomes. Thus, financial contingency planning is a proactive activity carried out in advance of any potential unfavourable situations.
Why are financial contingency plans important for your business?
There are numerous advantages to having a solid financial contingency plan. The following are some of the most important reasons to have a well-thought-out contingency plan in hand.
• Minimise the potential damage
Firstly, a well-crafted contingency plan for your business reduces the ramifications of a catastrophic event by preparing for the worst. For instance, the ongoing Covid-19 pandemic has affected a number of companies in the UK and throughout the world, and although it would be difficult to prepare for such an exogenous shock, having a solid financial backup plan would at least offer your company a chance to endure the economic downturn.
• Avert panic and encourage to take action
Likewise, having a Plan B prevents panic and promotes proactive behavior. In times of crisis, people often get frantic, and when there is no plan to follow, individuals are unable to make any decisions. Hence, businesses that have detailed contingency plans are more likely to overcome their initial fears, make better judgments, and get back to re-establishing normal company operations.
• Encourage evaluation of the existing business situation
Developing a business contingency plan gives you a chance to assess your company's operations and financial health. Accountants and finance managers, as well as other senior business executives, must collaborate to evaluate a company's assets, liabilities, and growth prospects. This in turn can help to uncover the organisation's weak areas, so they can be addressed in an effort to make the business more resilient overall.
• Prepare for positive situations
Finally, it's critical to emphasise that not all contingency plans are created to address the worst-case scenarios. In the event of a positive shock, such as an unexpected rise in sales for your products and/or services, having a financial contingency plan is equally vital since you may not have the capacity to accommodate the increased demand. In this manner, a financial contingency plan may help your company fully capitalise on these opportunities.
What to consider when drawing a financial contingency plan?
With so many variables to take into account while building a financial contingency plan, company owners must consider a number of steps.
1. Identify potential risks
First and foremost, it is a good idea to determine the potential causes and risks that might lead to failure. Making a list of several threats that your organisation may face and when they are most likely to occur should enable you to anticipate what sort of financial resources or levers you will need to use.
2. Determine the strategy for plan execution
Once you've identified your probable scenarios, the following step is to evaluate who and how will carry out the plan. Having a detailed process map that outlines how you, as a company owner, and your employees will address the situation helps you to react quickly.
3. Analyse your company’s financial health
Now that you have a clear list of the worst-case scenarios for your business and a detailed action plan, you can delve deeper into the financial intricacies of each risk. You should make use of all the financial planning and analysis tools available to you in order to fully understand your business operations and the markets you serve.
To begin, talk to your accountant or use your accounting software to get detailed data and visualisations that will provide you with a clear picture of your business's financial health. Additionally, conduct an inventory of your assets and sources of financing to determine the quantity of cash on hand, the critical assets that must be protected, the possibility for rapid borrowing, and similar issues.
During this process, you may learn that your financial situation is not as strong as you thought it was, but you'll be able to concentrate on the weaker areas to avoid a catastrophe that may halt your business operations.
4. Make plans to leverage resources and reduce costs
Whether you need to dip into your financial reserves, reduce production, borrow money from a bank, or even sell your business, for each worst-case scenario you must determine the best course of action. Furthermore, if your lenders are worried about your company’s financial soundness, they can potentially revoke lines of credit. Therefore, as a business, you must consider alternative funding options in order to maintain the company's operations.
5. Review the plan regularly
Changes in the market environment might expose a company to new and unidentified challenges. Your strategy and contingency plans must be reviewed and adjusted frequently as your business grows. Regular revision of your financial contingency plan ensures that your company's financial health is constantly evaluated in light of potential threats.
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