Financial contingency planning

When the owners of a start-up mail-order rental DVD service pitched an offer to sell their company for $50 million in 2000, no one thought the company was worth the price tag. It was losing money—not a good sign—while the industry Goliath, Blockbuster, saw its earnings rise both in U.S. and global markets. A decade later, the unthinkable happened, and their fortunes reversed. Blockbuster filed for bankruptcy, while the start-up Netflix generated nearly $270 million in net income.

The story is now industry folklore, a cautionary tale about the dangers of ignoring shifting trends in the market and the emergence of disruptors. It's also a great reminder that business leaders need to be proactive in developing a plan to pivot when faced with an unforeseen event that shocks the system and threatens the company's future.

Consider the following scenarios:

What if a machine fails and slows production in a factory?
Globally, machine malfunctions cost large production facilities more than 300 hours of productivity and hundreds of millions of dollars each year.

What if multiple team members quit at the same time?
More than 50 million people left their jobs in 2022. In 2023, a six-week strike by United Auto Workers members cost General Motors more than $1 billion.

What if a company's merchandise doesn't arrive in time?
IKEA and Lenovo had to wait until the cargo ship "Ever Given" was dislodged from the Suez Canal in 2021 and released by the Egyptian government before they had access to millions of dollars of merchandise sitting on the ship.

Risky Business

Manufacturers, distributors, and retailers play an integral role in the economy, providing the goods needed to keep businesses and households functioning optimally. The Covid pandemic revealed to the world how disruptions in the supply chain decrease supply, slow production, and lead to price increases—all of which can wreak havoc on everything from the supply of toilet paper in the grocery store to the production of automobiles.

A global pandemic isn't the only threat companies should consider. Over the last decade, several big-name companies (including the US's oldest department store, Lord & Taylor) closed their doors, many of the victims of changing preferences, devotion to legacy systems, and poor planning. Proactive stakeholders must consider how the following factors affect the company's bottom line.

Consumer Behavior Shifts: Laments about changing consumer behavior is familiar among retailers. About 20 years ago, all eyes were on the impact of big box stores in local communities. Today, the talk centers around the rise of online shopping. In 1999, online sales accounted for less than 1% of all retail sales, increasing to more than 13% by 2021. Retailers that want to survive must consider how they will respond and adapt to changing customer needs.

Cyber Attacks: Digital transformation has helped companies improve efficiency and allowed them to compete in the global economy, but it also increased the potential risks of cyber-attacks and related security threats. A single data breach can cost a company millions of dollars. An outside source with access to the company's network can hold data hostage, exploit customer information, and damage the company's reputation.

Inflation and interest rates: In the wake of the pandemic, businesses faced tandem inflation threats and rising interest rates. Higher wholesale prices cut into profits, and higher consumer prices increase the cost of living for employees who may demand higher wages. At the same time, interest rate hikes have lowered access to capital for some companies. When a company files for bankruptcy, the effects reverberate through the entire distribution chain, reducing orders from wholesalers and retailers.

Regulatory changes and sustainability: Regulations sometimes change frequently, and falling out of compliance can be costly to an organization. For example, NAM reports that US  manufacturers spend an average of $277,000 per company per year to stay within compliance.

Staffing shortages: The national labor market has been surprisingly robust throughout the most recent inflationary period, but several wholesalers and retailers have struggled to keep staff. Although the Great Resignation appears to have subsided, some industries still have high quit rates as employees seek different work opportunities. Staffing shortages slow production, affecting every organization along the supply chain. Failing to keep up with changes can cost more than a fine as customers are increasingly favouring companies with sustainable practices.

What is a contingency plan?

A contingency plan spells out exactly what a company must do when faced with a threat, from supply chain disruptions to launching a new competitor in a space. It's more than a Plan B, though. It's a safety net and disaster recovery guide detailing what steps to take when the original plans are derailed.

What is contingency planning?

Although some people may use the terms interchangeably, there is a crucial difference between a contingency plan (the completed document) and contingency planning (the analysis leading to the document's creation). The plan creates a path for the company to resume and continue regular operations when faced with a threat, and it accounts for the possibility of multiple threats.

Contingency planning is an integral part of the creation process. It requires an in-depth analysis of the company's current situation and careful consideration of potential threats to its well-being. In addition to identifying the potential dangers, planning involves assessing the company's resources and possible mitigation steps to determine the best course of action if the plan must be implemented.

How a contingency plan works

The contingency plan is a risk assessment tool that requires careful forecasting and details on how the company will respond to unexpected events. Similar to an emergency plan, it describes each step to take and who is responsible for every action.

For example, a plan for responding to a global recession that slows consumer spending may include a list of credit lines available (ideally already established while the business is healthy), what expenses they can be used to cover, and who has the authority to access them. A plan to implement in the wake of a natural disaster may include a list of insurance policies available to cash in to pay for expenses and a timeline for rebuilding property damaged in the disaster. In the event of a corporate executive's unanticipated death or resignation, the contingency plan may outline the succession plan, including how team member responsibilities will shift.

How does a contingency plan mitigate risk?

The most important advantage of having a contingency plan is that it helps ensure the company can navigate a threat successfully. However, its usefulness extends beyond this obvious benefit of keeping the company in business. It also allows leaders to mitigate the damage caused by the crisis so that the business continues generating a profit, the stakeholders remain confident, and the company's reputation remains strong. Establishing a plan also allows employees to respond to the crisis swiftly and immediately. This is important because people often feel overwhelmed during a crisis and may not have the mental or emotional bandwidth to make necessary decisions.

Companies with a contingency plan typically recover faster after dealing with adverse events. They also tend to suffer less damage to their property, reputation, and staff morale. Everyone from shareholders and employees to vendors and customers will feel more confident in the company's ability to navigate a potentially devastating situation when they know someone has created a response plan.

What information should be included in financial contingency planning?

The four major components of a contingency plan are the resources, risks, responses, and action plan. During the contingency planning stage, the team creating the contingency plan should identify the company's resources and analyze how they fit into the final plan. This includes the following tangible and intangible assets:

• Financial resources: Funding sources, liquid assets, such as cash reserves, stocks and bonds, and deposits in financial institutions
• Human resources: Personnel, including their knowledge, expertise and skills
• Intellectual property: Patents and trademarks, corporate brands, files and processes
• Material resources: Machinery and equipment, real estate, supplies, and tools

After completing this analysis, the team can focus on the key components of financial contingency planning.

Key risks

Identifying potential unexpected events is an essential step in the planning phase, and these risks should be described in the plan. Ideally, the risk assessment includes the following:

• Competitors entering the industry
• Customer satisfaction and preferences
• Cyberattacks
• Disruptions in the supply chain
• Economic downturns and market changes
• Equipment failure, including technology interruptions
• Natural disasters
• Staff changes, including resignations and strikes

Although anticipating and preparing for these risks is essential, the contingency planning team can't know which threats the organization will face and their potential impact. However, including the possible risks in the final plan gives the response team an understanding of the nature of the threat and how it can potentially affect the company.

Responses

No two crises are alike, and neither is the most appropriate response. For example, after a natural disaster, the crisis management team may need to assess physical damage to the company's property before taking steps to resume normal business operations. This is not necessary when addressing damage to the company's brand. Typically, responses fall under one of three categories:

• Risk management: Repairing damage caused by the threat, like assigning employees to new roles after a resignation.
• Risk mitigation: Reducing the possibility of secondary damage caused by the threat, such as customer satisfaction in the wake of a data breach.
• Risk transfer: Activating an insurance policy to pay for physical repairs to company property instead of using financial reserves.

The response team also needs to know when to activate the disaster recovery plan. The plan should include specific descriptions of the trigger points and detail how they should make decisions. Some decisions are best left to a single person within the chain of command, while others should be made by a team of people to protect the company's interests.

For example: a factory might need to stop production while a key machine is repaired. If the company has enough of the product in reserve, the team likely does not need to implement the contingency plan because business between the company and its customers can continue as normal. If the machine is down for an extended period because of a lack of parts, the response team may need to activate the contingency plan to draw from a line of credit and repair any damage to the company's reputation caused by the production delay.

Plan of action

Finally, the contingency plan needs to detail each step the response team needs to take. For each step, the plan should include the names of the individuals responsible for carrying out the actions, a timeline for completion, and the resources they need. It's also helpful to include templates for emails, website announcements, press releases, phone calls, and media scripts. Define who the team members need to notify, what information to share, and which communication channels to use. This information helps the team with decision-making to respond more efficiently to the situation.

With Phocas's FP&A platform, you can access a suite of tools that make financial contingency planning simple. Our human-friendly technology helps over 3,000 mid-market manufacturers, wholesale distributors, and retailers access crucial financial data needed to conduct thorough sensitivity and scenario analysis, and build robust financial contingency plans.