Contingency Fund – Source of Courage

We often use the word “Contingencies” casually for defining emergencies and unexpected events while planning. Do we really provide for “Contingencies” of our life? I am not referring to having insurance, yes, it’s necessary to have insurance which will take care of financial needs of family in case of bread winner’s death or in case of medical expenses or any other mishaps like damage to car, house etc.

I am talking about contingencies which do not fall in any of the insurable category.

We all have experienced such a contingency recently when total lockdown of 3 weeks was announced by our PM. Many would have had the first though about how to run the show, how to meet daily household expenses and so on. Business owners were worried about how to meet the obligations of salaries and other payments.

On the other hand, there also was a class of people who were not worried and enjoyed the lockdown period spending quality time with family. What was the defining distinction? It was obviously not the amount of monthly income or the net worth. Those having higher incomes had higher expenses as well.

The amount of contingency fund available, may it be for business or at personal level, played an important role during the total lockdown.

How much contingency fund is right? It is really difficult to give a general answer which will suit all, but in my opinion at personal level minimum amount which will take care of 6 months of household expenses and maximum up to 3 years should be good to have as contingency fund. This amount should be separate from your long & medium term investments, it may be invested in any liquid assets.

For business, there is a ratio named “Cash Interval Ratio”, there may be different names used by various authors, but that’s not important. This ratio is about calculating the period for which business can run normally even if not a single rupee flows in. This usually is represented in “Days”. More the days, better the position. Still there is no optimal ratio or days which can be said to apply to all. There is also a flip side to the same, when any business has enough funds to survive for many days without inflows, it means it has a lot of ideal funds, it also means the decision makers are too conservative, may be even pessimistic about future, which obviously has impact on growth of business.

Having sufficient contingency funds will enable the person or business owner to take bold decisions or wait for right opportunity and not force to go for anything that comes on the way. For ex. A person losing a job and trying to find another job, he can certainly pull on till he finds a suitable job, having contingency funds will not force him to take any job that is available. Similarly, for business owner, he will not be forced to go for any order, which may be loss making or with paper thin margins, just for managing the cash flows. Thus, contingency funds can be said to be source of courage.

CA. Avinash Shukla

Email: caaashukla@gmail.com

Mo: 9890184190

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