Why Contingency Budgets Are Crucial for Businesses

Business is never about risk mitigation; it's always about risk management. You cannot get rid of risks as long as you are running a business.

The conventional wisdom would suggest that the concept of a contingency budget is a manifestation of a risk-averse attitude. Saving money for unpredictable emergent situations reflects a conservative approach towards business.

In this article, I will discuss how contingency budgets enable you to take more risks. If you think about allocating a contingency budget, money is a tool used to deal with unseen and unknown future; it is not the end goal.

Broadly, any kind of risk can be constructed based on two parameters:

1. With respect to scale (Low risk and High risks)

2. With respect to consequences (Reversible and irreversible)

So, effectively, any risk will fall into one of the following four categories:

1. Low risk with reversible consequences

2. Low risk with irreversible consequences

3. High risk with reversible consequences

4. High risk with irreversible consequences

Based on this framework, the first three categories can be managed easily and do not necessitate much deliberation in decision-making. Though, all kinds of risks should be contained before spilling out of control.

For the interest of this article, only the fourth category is in our focus: high risk with irreversible consequences.

Every transformational decision falls into the fourth quadrant of the risk graph. In this quadrant, risk is high and consequences are irreversible. Once you fire the bullet, you cannot take it back. Such high stakes make every decision-maker cautious and deliberative.

On the other hand, every few years, businesses face the dilemma of maintaining the status quo or making transformational changes to adapt to the changing needs. At this inflection point, situations warrant transformational course correction to be done at the right time. It is a drastic change needed to be done without facing extinction.

This paradigm shift requires capital investment without any immediate return, and investing money from the existing business may squeeze the market share. So, having a contingency budget works as a start-up's initial capital, which enables you to take the necessary risks to deal with forthcoming challenges without hindering the existing business.

Benefits of Contingency Budgets:

1. Risk-taking becomes easier: Risk is not free, and the cost of risk can be predicted only to a limited extent. In such uncertain scenarios, taking risks that can pose a threat to the entire business would not be wise. Hence, keeping aside a separate budget gives the leverage to take more risks.

2. Contingency budget provides the last mile of defence: We know nothing about the future except that it will not remain constant, and the outcome in any business is predicated on anticipation, expectation, and prediction. At the end of the day, the truth is that anything can go astray. Having a contingency budget provides the last mile of defence for your business.

3. You can take care of long-term interests: Pursuing any worthwhile, meaningful endeavor takes time. In the meantime, one has to deal with various setbacks that can divert you from the long-term vision.

4. Peace of mind: Finally, peace of mind is not a bad thing to have. At the end of the day, every decision boils down to act or not to act. It could be tricky without any safety net to deal with the worst-case scenario. So, why not decide.