What is a Financing Contingency?
A financing contingency is a plan for unforeseen circumstances that may financially impact you, an investment, or your business.
A contingency plan maps out potential risks for your company and strategizes actions to take should one of those risks occur.
Management teams typically create and implement financing contingencies to cover a myriad of hurdles. The goal is to help your business maintain operations in the midst of emergencies. In real estate and other investments, it's a contract between buyer and seller in order to protect the buyer from unexpected financial obstacles.
Why do you need a financing contingency?
Accidents happen. Emergencies happen. Life happens. It's good to be prepared. Whether it’s a natural disaster, economic instability, bankruptcy, rocketing sales, or cornering a new market, a financing contingency just makes practical sense. Other reasons include a technology hack, losing the majority of your staff or a major client, litigation, theft, terrorism, and a pandemic.
Contingency contracts prevent or minimize risk of a future event that can cause detriment to you or your company. A financing contingency prioritizes what to do with financial resources if your business is threatened.
Likewise, it aims to speed up recovery from a negative blow. Being prepared helps you maintain business operations, including production, salary, or debt payments. Your plan should cover business expenses for at least six months, especially if there's an unexpected drop in revenue.
It’s best to identify a range of possible risks and analyze why these situations may occur. A financing contingency tracks indicators or red flags and helps you to identify and stay on top of the situation. Should those red flags appear, the plan will allow you to continue business as usual during tumultuous times and keep your business in good standing. You can then take action by prioritizing what to do and when to do it.
What does a financing contingency look like?
Two goals exist for a financing contingency: the immediate response to a crisis and the recovery response for normal operations after a crisis.
Existing credit or cash reserves, short-term loans, and business continuity insurance are immediate emergency responses. A long-term plan to operate business as usual is temporarily spending more of your funds on the harder-hit areas.
Create a set of guidelines to identify your resources, potential risks, and positive or negative impacts your business could see. Look at worst-case scenarios to show where or how your business might suffer the most. Scope out the risks, and come up with possible strategies for mitigating negative circumstances. Gather and analyze the data to devise a plan for each potential contingency. Lastly, don't forget to include any positives that may also dramatically change your business.
A financial plan sets up a financial profile and lays out the business' target market, operations, costs, cash flow, and operating expenses. It also highlights top competitors, creates an inventory of assets, and lists possible funding.
Consider scaling down production, reallocating resources, cutting costs, laying off staff, and renegotiating contracts. A contingency plan could also extend payment options to debtors, collect early payments from clients, increase lines of credit, and get rid of unprofitable business units.