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Maintaining Company Stability --- Contingency Planning

Written by: Dr. Rick Johnson

Article Overview: A “Contingency Plan” is a plan developed for a specific situation when things “could” go wrong or are going wrong. Contingency plans include specific strategies, initiatives and actions designed to deal with identified variances to assumptions. These variances usually result in a particular problem, emergency, or state of affairs. The plan also includes a monitoring process and “triggers” for initiating planned actions.

Maintaining Company Stability --- Contingency Planning

A "Contingency Plan" is a plan developed for a specific situation when things "could" go wrong or are going wrong. Contingency plans include specific strategies, initiatives and actions designed to deal with identified variances to assumptions. These variances usually result in a particular problem, emergency, or state of affairs. The plan also includes a monitoring process and "triggers" for initiating planned actions. They are required to help businesses recover from serious incidents or economic crisis in the minimum amount of time with minimum cost and disruption. Contingency Planning is a management process that identifies potential impacts that threaten an organization and provides a framework for building resilience and the capability for an effective response and possible recovery if required. Once the initial contingency planning session is complete, ownership must decide exactly who will be part of the contingency planning team to execute the plan. An effective contingency plan must be fully integrated into the organization as an embedded management process.

Economic Turbulence May Demand Contingency Planning Contingency planning is often essential and unavoidable during economic turbulence. However, the creation of a sound contingency plan is a complex undertaking, involving a number of stages and discrete activities. For example, initially it is necessary to understand the underlying risks and the potential impacts of market decline.... this becomes the building block upon which a sensible business continuity plan must be built. Every aspect of the plan must be carefully managed to ensure that it does not fall short of recovery and maintaining the company's stability.

Ownership must decide exactly who will be part of the contingency planning team to develop and execute the plan. Additionally, tactical questions & objectives include;

• How will meetings be run (e.g. pure status reporting up front)
• Who will record the notes, etc.
• Frequency and agenda for team meetings
• Operating principles while the plan is in effect (e.g. team approval of expenditures over $)
• How to address accountability and progress measurements

Multiple Budgets

The platform for contingency planning due to a financial crisis is the multiple budget process. This contingency budgeting process is survival action planning and should not be taken lightly. It should not be entered into with a haphazard approach.

Objectives include:

• Gross margin improvement
• Increased market share
• Decreased overhead
• Cost containment - Death by a Thousand Cuts
• Stable customer service
• Supply chain management
• Retrenchment - reduction in force if necessary

So Where Do We Start? Step #1

All budgets generally start with a sales forecast. Go back to the Vice President of Sales and request a new, realistic forecast. By the way, sales management is intimately involved in this process. Chances are the new realistic forecast received from the sales force is going to be highly optimistic. It is by nature difficult for any salesperson to forecast anything other than solid growth regardless of conditions. This is especially true if their incentive is based on revenue growth. The Chief Financial Officer (CFO) takes that forecast and using historical percentages creates a proforma (a projected Profit and Loss statement based on the forecast). Unless your sales force is unique and turned in a forecast showing no growth or a revenue decline, this forecast and proforma becomes a basis for your "Optimistic Budget."

Step # 2

The next step is to take the current year's actual performance and extend it through year-end and determine the profitability or the extent of loss expected. Additionally, take the prior year's actual Profit and Loss statement and post it openly in the "War Room." I mention "War Room" because you must have a convenient, confidential place for your contingency planning team to meet regularly and develop your plan. It's called a "War Room" because there can be a lot of blood shedding involved in a situation when the company faces substantial economic crisis.

Create a proforma for a realistic forecast and a catastrophic forecast just as you did for the optimistic forecast. These three proforma's become the platforms to build your three new budgets. If you are in the first half of the year, you use last year's actual numbers as a basis for determining your three new budgets. If you are in the latter half of the current year and can accurately predict year end results without the impact of any of the changes discussed in your assessment process then use that annualized proforma as your basis point.

The three budgets you need to prepare are called "The Catastrophic Budget," "The Realistic Budget," and "The Optimistic Budget."

The Optimistic Budget Calculation In calculating the necessary expense reduction and margin improvement the optimistic budget takes your platform year proforma revenue as the forecast. You could even adjust it by a small percentage according to individual circumstance. The idea is to demonstrate credibility in recognition of the possibility that conditions can become much better than anticipated. In that event, you are prepared to execute according to plan. Your budgeted revenue becomes a higher number utilizing historical data and percentages; you calculate your gross profit dollars. You then take your platform year's budgeted total expense (without any restructuring adjustment) and subtract that from the gross profit dollars. This shows your resulting pretax profit or loss.

The Realistic Budget Calculation In calculating your necessary expense reduction and margin improvement the realistic budget takes your platform year proforma revenue and decreases it 5 to 20%. This may vary according to individual circumstance. The idea is to demonstrate credibility in recognition of the possibility that conditions can become much worse than anticipated. In that event, you are prepared to execute according to plan. Your budgeted revenue becomes a lower number recognizing economic turbulence; next you calculate your gross profit dollars. You then take your platform year's budgeted total expense (without any restructuring adjustment) and subtract that from the gross profit dollars. This shows your resulting pretax loss or profit.

Your objective in making a presentation to your bank should be to convince them that you will end the next year with an achievement somewhere between the realistic budget and the optimistic budget. If your presentation is done well, backed up by facts with definitive initiatives and action plans, the bank will probably believe that you will end the next year somewhere between the realistic budget and the catastrophic budget. That's okay because that means you have stopped the bleeding and will end the year a stronger company, in control of your destiny and with the ability to turn next year into a very profitable year.

The Catastrophic Budget Calculation In calculating your necessary expense reduction and margin improvement, the catastrophic budget takes your platform year proforma revenue and reduces it according to your forecast. (a 20 - 50% decline) This may vary according to individual circumstance. The idea is to demonstrate credibility in recognition of the possibility that conditions can become exceptionally worse than anticipated. In that event, you are prepared to minimize your losses by initiating your catastrophic budget. Your budgeted revenue becomes a reduced number from your platform year (based on economic predictions-this reduction could be substantial). Utilizing historical data and percentages, you calculate your gross profit dollars. You then take your platform year's budgeted total expense (without any restructuring adjustment) and subtract that from the gross profit dollars. This shows your resulting profit or most likely your resulting pretax loss.

Closing the Gap The three budgets indicate exactly how much cost reduction will be necessary to meet specific profit objectives established for each budget. The catastrophic budget may actually acknowledge a forecasted loss or break-even at best. Now it's time to close the gap and create the actual contingency plan. This plan should list detailed strategic initiatives, action plans, critical constraints, milestones and key performance indicators to be used in the accountability process. All numbers and spreadsheets showing data crunching must back-up the contingency plan. The basic methods used to "close the gap" are:

• Reduction in force
• Cost containment (death by a 1000 cuts)

Gross profit improvements may not be realistic due to the market dynamics during economic turbulence. However, pricing and purchasing opportunities should be explored to determine if changes in process, control or effectiveness can contribute to an increase in profit margins. Many times closer management of the pricing system alone can produce an increase in profit margins without increasing prices. This could contribute to closing the GAP. Each budget should be categorized to reflect how the "Gap" (deficit) is to be closed.

•I. Operational Strategy Red Light-Yellow Light-Green Light

Once the budgets are compete and the GAP closures (cost reduction initiatives) are identified, you must determine the timeline for execution and at what stage of economic crisis the company is in. How do you know when to initiate further cost reductions, when to relax and when to be on guard? In turbulent economic times, you must be able to act and react quickly. You will be observing numerous indicators. Interpretation and understanding of these measurement tools is critical. These indicators may include among others:

Internal

• Cash to cash cycle
• Operating profit
• DSO-accounts receivable
• Payables ageing-trend line
• Gross margin %
• Gross margin $
• Quote activity
• Backlog
• Book to ship ratios
• Head count
• Specific initiatives
• Budget analysis
• Book to quote ratios

External

• Interest rates
• Manufacturing backlog
• Purchasing managers index
• Business publication reports
• Government statistical web sites
• Association reports

The red light, yellow light, green light scenario establishes what mode you should be operating in based on the key indicators you have established.

Red Light → Catastrophic Plan

Yellow Light → Realistic Plan

Green Light → Optimistic Plan

In a contingency situation you automatically implement the realistic plan in a precautionary status. You are in the yellow light mode. You determine when and if you move to either the red or green mode by tracking your indicators.

Window of Opportunity The state of the economy is a fact. How you feel about that fact and what it means to you personally is a belief. Your beliefs have a major impact on your employee's attitude. Beliefs that drive your sales behaviors are the keys to becoming successful in a down economy. If you believe that this economic crisis can provide you with opportunities, then your attitude will drive the behavior of your employees.

This is Not the Time to Panic. Yes, there are economic problems, but there are also opportunities! Leadership during these tough economic times is about not panicking, and that's exactly the message I want to get across... don't panic! Panic causes knee jerk reactions, and they're rarely correct. Deliberate leadership, clear thinking and solid contingency planning strategies will lead to success and recovery. Panic leads to failure. As a leader you need to be deliberate, thoughtful, and take the actions necessary to stabilize the future of your individual business.

Related Articles
  6.1 Macroeconomic policies for diversification: Economic Report on Africa 2007
  Do you want to succeed in a down economy? Many have; you can too.
  Discipline and Attitude Essentials for Difficult Times
  Planning for the Unthinkable
  Gutless Management

Article Tags: company stability, contingency plan, contingency planning, recession



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