3 Mins
We have recently been providing some businesses in financial distress with Contingency Planning and this article sets out what Contingency Planning is and why it is a useful exercise for distressed businesses.
When a business is in stress or distress, the key focus for management is how the business can recover and continue to operate whilst minimising the impact on stakeholders. Where formal insolvency cannot be avoided, it is best for this to be a controlled process. Contingency Planning is the backup plan which is ready to implement if the business cannot avoid insolvency. It is all about understanding the impact of insolvency on different stakeholders and how to manage it.
The importance of Contingency Planning
A Contingency Plan sets out possible risks and actions to mitigate these in the event of unforeseen circumstances.
The benefits of a Contingency Plan are that it:
- Considers risks and actions that should be taken when risks materialise
- Enables the early execution of a controlled plan
- Increases the chance of the best possible outcome being achieved and
- Helps a business avoid crisis management.
A Contingency Plan for a business will consider:
- The financial position
- The risk management processes, current and future risks to the business and how these can be mitigated
- Management of working capital and how value can be preserved in the business to reduce the impact on stakeholders
- Management of the supply chain
- Management of stakeholders
- The business’ continuity plan and
- The options available to the business including insolvency as a worst-case scenario.
A Contingency Plan should be reviewed and updated on a regular basis.
A licensed Insolvency Practitioner can help prepare this plan when a business has concerns about its financial position so that all available options can be explored as soon as possible.
Financial position
A business should assess its current financial position. It should analyse its assets, liabilities and cash flow to assess the risk or severity of financial stress or distress and consider the timescale available to resolve before the company becomes insolvent either on a balance sheet basis (liabilities exceeding assets) or cash flow basis (inability to pay debts as and when they fall due).
It should also assess its funding and investment position and consider future options available to it to access additional working capital and investment.
Risk management
There should be careful consideration of all internal and external factors which present a current or future risk to the business.
Risk of insolvency within the supply chain
A business should consider all aspects of its supply chain and the risk of its suppliers and customers facing financial difficulty/becoming insolvent themselves.
A business should consider:
- Who its key suppliers and customers are
- The enforcement options available to recover outstanding debts and the associated costs and timescales
- Whether it would be able to source replacement goods or services quickly in the event of a key supplier becoming insolvent and what the impact would be
- Whether it could replace lost revenue following the insolvency of a key customer and how quickly this could be done
- Whether the performance of contracts would be affected by the insolvency of a key supplier or customer
A business should have regular contact with key stakeholders, monitor their financial position and review any wider industry intelligence available. A business should consider whether there are other market/industry pressures which may affect a stakeholder’s financial health.
A business should look out for warning signs that a stakeholder is experiencing financial difficulties.
Suppliers may remove credit facilities, require payment in advance or push for payment quicker than the agreed payment terms. Customers may push for credit to be supplied, become slower to pay or not pay at all.
Stakeholder management
To maintain trust and manage expectations, a business should have open communication with stakeholders and provide regular updates on the financial situation, plan for recovery and any impact on stakeholders.
A business should be clear on any formal notifications required by Regulators in the event of financial stress or distress and have an early dialogue with Regulators if problems arise.
A business should also have early communication with key creditors such as lenders, HMRC, and pension funds and should consider creditors’ concerns.