Financial contingency planning is a must—not just for established small businesses, but also for businesses in the earliest stages of formation.
If you’re pre-launch or have only recently gone to market, a contingency plan is likely to be the last thing on your mind; after all, your efforts are focused on making your business a success, and not necessarily thinking about what could go wrong.
But unexpected situations can interrupt the launch of a business and disrupt normal operations. Without a financial contingency plan in place, these unforeseen events can be harmful to the health of the business, potentially leading to insolvency before a startup is even off the ground.
Working for a firm of turnaround practitioners, I provide expertise in terms of business recovery, cash flow, and financing. I commonly see perfectly viable startups that are simply unable to function due to a lack of cash flow. For businesses in the earliest stages, funding streams are often not available, which gives them little choice but to fold. Putting a simple financial contingency plan in place can give businesses in this situation the lifeline they need.
In this article, we’re going to explore why financial contingency plans are so important and help you create your own for your early-stage business.
What is a financial contingency plan?
A financial contingency plan should document your course of action in times of crisis that threaten the stability of your company. It should focus on resource and financial allocations in particular.
It can mean the difference between the survival and failure of a business when disaster strikes, whether the crisis stems from a late payment, the loss of a credit line, or equipment failure.
Why are financial contingency plans so important?
At the start of this year, 5,593 businesses were on the verge of insolvency in the U.K. Many of these businesses would be perfectly viable, but they are simply suffering from financial management issues. For example, they may generate a revenue but have falling profit margins, or have issues with chronic late payments due to the lack of an effective collections procedure.
In the early stages of a business, there are often simply no resources to absorb any unexpected negative events. That’s why a comprehensive plan that aims to limit the risk of financial loss can be invaluable. Rather than panicking and fearing the worst, startups can implement practical and effective business strategies to remain operational and avoid insolvency.
As an aside, a financial contingency plan cannot protect you against every financial situation. Other issues, such as problems making tax payments or issues around simply growing too quickly, can also threaten to derail new businesses. If you’re looking for more information on the subject, head over to Company Debt (where I serve as head of digital) after you’ve finished this article. We offer an extensive range of resources and guides to help resolve many challenges you might face.
How to create a financial contingency plan
Follow this process to create a financial plan you can rely on. Importantly, each of these steps is simple and completely doable. Don’t be intimidated. The whole process should take no more than an hour of your time.
1. Create a list of your priority resources
Not all your business’s resources are crucial to its operation. Although they may be few and far between in the early days, what resources you can operate without if it means the difference between keeping your doors open and folding?
For example, do you own a business vehicle that is nice to have but is not critical to the business’s core activity? Or perhaps you own a brick and mortar location you could sell if the survival of your business depended on it? Equally, there may be less essential members of staff you could let go if the business was struggling financially. Remember, it will almost certainly be easier to think through your bottom-line essentials now, rather than in the heat of a crisis.
2. Consider the potential risks
There are a limited number of risks that could lead to failure. In fact, the risks are usually relatively easy to foresee, even if you’ve yet to launch. For example, what would happen if a key customer went elsewhere, or if an important team member left the business? With the right planning, as long as there’s demand for the products or services you offer, it is possible for a business to survive any kind of risk.
Make a list of possible risks and give some thought to how likely each of the threats is to occur and when they are most likely to occur (conducting a SWOT analysis can be helpful here, too).
For each of the threats, you should:
- List the strategies and techniques you will use to minimize the risks
- Detail the techniques you will use to mitigate the financial impact of the risk if it should occur
3. Determine how to execute the plan, and who will be responsible for what
Take the information above and determine who will be responsible for executing the financial contingency plan. As a startup business, this responsibility will likely fall on the business owner. You should also map out who will have access to the documents needed to act upon the plan before and during the process, and include a list of the team members who will know about the plans before they are put in place.
4. Review regularly—make sure your plans are up to date
The type of risks businesses face change at different stages of their development. The threat of late or non-payments is one of the leading causes of business insolvency, as is the insolvency of a company within the supply chain. However, before launch, your biggest threat is more likely to be whether you can secure funding.
There can also be changes to market conditions that expose the business to new and previously unidentified threats. To make sure the financial contingency plan is relevant and up-to-date, it’s essential you revisit and revise the plan on a quarterly basis as the business grows.
5. Identify alternative sources of credit
These days, it is not uncommon for lenders to remove lines of credit or for trade suppliers to reduce the credit they offer your business if they are concerned about its financial stability. Proactively identifying alternative sources of credit that can be secured and assessing their financial feasibility will help the business continue operating if credit lines are reduced.
This should be a process that is revisited on a quarterly basis as the range of finance options available to your business will change. Don’t wait until your credit line is removed to start thinking about this risk—it can take a long time for startup businesses to find alternative funding sources.
6. Consider the capital requirements first
The typical approach to contingency planning is to decide what’s best for the business first and then think about where the money to implement the plan will come from.
However, when creating a financial contingency plan for a startup, the probability of accessing the capital you need is relatively low. For that reason, it makes sense to explore the capital markets first and then adjust your strategic plan accordingly based on the money that’s likely to be available. Keep an eye on your financials on a weekly or even daily basis—you can do this with an Excel spreadsheet or a dashboard that pulls in your data automatically from your accounting software.
Make sure you’re comparing your cash flow projections with actuals on a regular basis so that you can head off a crisis before it has a chance to grow into something that threatens the existence of your business.
Creating a financial contingency plan may not be the number one priority for startup businesses. However, with 4 out of 10 UK businesses failing in their first five years, this is something those that are serious about their survival should give serious thought.
The truth is, there’s no substitute for proper preparation, and putting plans in place if the worst should happen can provide reassurance and respite during a financial storm.