With the best will in the world, it’s unlikely that your business planned for a pandemic. There are some things that you just cannot predict.
The recent months have undoubtedly had a major impact on how businesses operate. They’ve also elevated the role of scenario planning as it helps businesses deal with what the past few months have thrown at us.
As we head towards the traditional budget season (August-December), finance leaders are busy compiling models to map out potential paths, and the significance of scenario planning is increasingly coming to the fore.
What’s the Point of Scenario Planning When You Can’t Plan for the Unknown?
When your organisation is aware of a multitude of things that could happen, leaders are more likely to spot warning signs of potential challenges and respond accordingly. When a worst-case event arises, scenario planning documents add tremendous value by playing out multiple outcomes and listing immediate steps to contain damage, or, in best-case scenarios – for example when product demand suddenly spikes, it lists immediate steps to maximise the benefits and enable your business to cope.
Scenario planning enables decision-makers to identify a range of potential outcomes that are based on assumptions about the forces driving the market, some of which are good, some bad. The result is an insight into the estimated impact, and positive and negative possibilities resulting from a range of responses. A business can project financial earnings and estimate cash flow in order to develop mitigating actions – although it’s important to remember that scenario planning is suitable for more than just as a financial planning tool.
Why Scenario Planning is Important
Now that your business is aware of most things that could happen, it remains to be answered why this is important. In short, scenario planning can provide a competitive advantage by enabling decision-makers in your business to react quickly and decisively, safe in the knowledge that a situation has been thought through and actions documented. There is no panic and scrambling for data to attempt to form an on the spot strategy.
For now, the focus is on coping with the new reality we face, but scenario planning also gives executives and boards of directors a framework from which they can make non-emergency decisions more effectively by providing insights into plans, budgets and forecasts and painting a clearer picture of key drivers for business growth and the potential impact of future events.
Choose Your Scenario Planning Type
There are four types of scenario planning from which you can choose from:
Quantitative scenarios are financial models that allow for the presentation of best- and worst-case versions of the model outputs. These models can be quickly changed by altering a limited number of variables/factors. This type of scenario can also be used to develop annual business forecasts. These models assume key variables are known and that relationships among them are fixed.
Operational scenarios are one of the most common types of scenario planning an organisation will undertake internally. Operational scenarios specifically explore the immediate impact of an event and provides the short-term strategic implications.
Normative scenarios describe a preferred or achievable end state. If you’re looking for a statement of goals then this is the type for you, steering away from objective planning and towards how a company would like to operate in the future. This type will often be combined with other types of scenario planning for the purpose of providing a summation of changes and a targeted list of activities.
Strategic management scenarios are essentially stories that say little about the company or industry, but more about the environment in which products and services are consumed. This type requires a broad industry, economic and world view and is often considered to be the most challenging for company leaders to put together. Although complex, planners retain more freedom to brainstorm decisions.
Scenario Planning & Modelling Best Practices
- The right team: While financial professionals can lead the scenario planning process, success won’t come if it’s done by them alone. A consolidated effort from leaders across the organisation needs to take place, including business units and HR.
- Use the right data: How many times have you heard this? Finance teams need to be able to execute with confidence, and to do that, they need the right data – and not just the general ledger. The strength and accuracy of a model relies upon finance having historical and comparative sales data, headcount and expected growth, as well as actuals from the general ledger. Understanding the costs of producing product and services, which products are foundational and which are additive, is also important.
- Model with basic scenarios: Basic low, medium, and high models should be developed by finance teams. A low model, where costs and revenues are challenging, will assist in finding cost savings whilst still delivering products in a timely manner. Medium scenarios assume that sales will continue to grow based on last period actuals. This scenario will show how the last period’s sales figures compare with forecasts, and what adjustments you need to make on headcount and other departmental spending to maintain trajectory. The high scenario is usually based on demand increasing and sales accelerating due to big changes in the market. The goal is to ramp up capacity without incurring costs that eat into margins.
- Provide break-even analysis: This analysis will support, with data, decision-making regarding your cash-flow break-even level. It looks at the minimum sales volume your company needs to keep operating normally and sales compensation plans to see if you need to adjust commissions or bonuses
Whatever the industry, the fundamentals of scenario planning remain the same, even if the particulars across industries and within businesses vary. Scenario planning can provide your business with the help executives need to be able to understand the effects of various plausible events and allows for finance, operations, and other teams, to prepare initial responses.
If you want to learn more about how to use scenario planning, what actions to take and what to avoid, or the steps towards improving your scenario planning, watch the webinar here.