What is Contingent Capital?

Contingent capital is a type of reserve capital that a company can draw upon when some type of unforeseen financial issue arises. Sometimes kept in what is known as a contingency fund, the idea behind this type of capital reserves is to protect the company from losses that could occur due to the failure of essential equipment or some other type of issue that could undermine the ability of the business to remain profitable. Depending on the policies and procedures followed by a given company, use of contingent capital may be limited to a relatively small set of events or circumstances, or use of the backup funds may be at the discretion of a select group of company officers who in turn are accountable to a board of directors for their decisions.

There are a number of ways to create sources of contingent capital. One approach that is often workable for small to mid-sized businesses is to create cash reserves that are placed into interest-bearing accounts, but are readily accessible in the event of an emergency. With this approach, a company can easily deal with a sudden event such as the loss of a major client by simply transferring some of the reserves into the general operating account, effectively allowing the company to continue honoring its own debt obligations while securing new clients to offset the loss.

Another approach to contingent capital is to establish a line of credit with a local financial institution. This approach may also be in the form of what is known as a standby loan. The idea is to make sure that the company has the means to obtain in influx of cash immediately in the event of some sort of natural disaster or other issue that threatens the ongoing operation. While this approach does not tend to provide the benefits of holding cash reserves in hand that earn at least a small amount of interest, a line of credit or a standby loan both provide excellent cushions for disaster situations.

When it comes to creating some type of contingent capital, even small businesses can build up some type of reserves for use in emergency situations. Often, having a financial contingency plan that includes easy access to cash makes the difference between overcoming the emergency and having to shut down permanently. Contingent capital can be used for everything from paying employee wages and salaries to buying new equipment to even setting up temporary operations at another location in the event that some sort of disaster has rendered the normal base of operations unusable.