How to Enable Efficient Scenario Planning
As the wheels of the world turn faster and faster, the need to experiment with your financial assumptions and your financial forecast increases. To do this quickly and efficiently, you should work with your scenario planning. This way, you’ll have a plan for how the business should act in different situations, and by that, you’ll be able to elaborate with internal and external factors to analyse what effect different decisions and events might have on the financial forecast.
In this article, I’ll give examples of scenario planning, highlight the importance of working with scenario planning, and clarify how to enable more efficient scenario planning for your business.
So, what is Financial Scenario Planning?
Scenario planning can be summarised as a financial method to identify various events and risks. Scenario planning is also about simulating and comparing different hypotheses in advance to make decisions about a path forward that optimises your financial outcome.
Some common examples are; what's the outcome if we experiment with changed prices and payment terms – how might this effect the customers and the sale? Or what if the currency drops by 10% at the same time as inflation drives the costs and salaries? What effect will this have on the cash flow? Should we pull the brake and stop recruitments, or is the best alternative to keep going as planned?
Historically, companies have often worked with scenario planning, which meant time-consuming internal work for the finance department. For some, getting a few individuals to do the work might be the best and quickest alternative. However, getting the business’s input can often be both relevant and necessary to increase the budget quality and for the responsible ones to understand the effect of different decisions
The importance of scenario planning
Unlike the budget that often works as a frame for the business, scenario planning aims to challenge the set structures. Your business should always know how to act when different scenarios occur - to make as good decisions as possible.
We can’t deny that scenario planning can be time-consuming. That’s why you must think through your goals and optimise the work process. If you succeed, working with scenario planning might help you:
- Create a more agile business that is more flexible when changes occur
- Understand key business factors and what effect internal and external changes lead to
- Give the business a feeling of being prepared for everything
- Increase the collaboration between departments and their ownership over the financial forecasts
- Help you handle an uncertain climate more efficiently
- Contribute to higher quality and more exact budgets, forecasts and strategic plans
- Identify new, better ways of driving and optimising the business
I also dare to say that you both increase your resistance and get an advantage over the competition that hasn’t yet created the right conditions for efficient scenario planning since you already have a plan and can act and react quickly. You've looked over all of your alternatives and know how to work and when, which reduces the risk of “panic” and poorly thought-through decision-making in a crisis.
How to enable efficient work with scenario planning
The advantages are, as mentioned, many, and apart from lack of time, there’s not much stopping you from getting started. However, doing the financial planning manually in Excel often creates an administrative challenge and restrains critical factors from being completed, such as working with automation and complex drivers. The needed tools have become more and more accessible in the last few years. During the previous turbulent years, we’ve seen that those working with a system have better qualifications for working continuously with their financial planning.
Six steps for completing the process
Identify the most critical drivers for your business. You’ll need these to make changes to the entire forecasting model with as few inputs as possible. For example, what happens when we alter our prices by 10% - how will this affect the income growth, costs and, in the end, cash flow? What effect will this have if you add sales representatives to an entity or alter the assumptions for salary developments?
To succeed with scenario planning, you’ll need a solid driver-based process that builds up your P&L.
Take advantage of the data
The available data continues to grow; it’s impossible to work in an agile manner with your financial planning without the correct data. You can work more qualitatively by integrating the proper systems such as your ERP with your financial planning processes. This will increase the confidence in the process, and enable you to make more qualified decisions based on the correct data and assumptions.
Examples of data include sales volumes, head count and salary data, historical accounting data etc.
Systemise & Automate
If you do not already have a system, you’ll need to identify what systems support, or can be customised to support, your business. A system that streamlines your entire financial planning process, where you can work data-driven and with parameters, is necessary to quickly and efficiently elaborate on different scenarios.
Take advantage of the system to automate available parts of the process that you can, this way you minimise the time spent on preparing and administrating new forecasting scenarios.
Where in the organisation are the insights needed to build up a qualitative forecast? It would be best if you decided on a reasonable involvement. If you’ve succeeded with the three first steps, it might make sense to do one scenario with a high degree of decentralisation. After that, you can limit additional scenarios to only involve the individuals in the finance department and the organisation that has the best insights into how that particular scenario should be handled. Everyone don’t need to be involved in all scenarios, but if you’ve created a driver-based process with a high degree of automation, the involvement doesn’t need be limited by the amount of time it takes to gather input from people.
Start with the easiest part
The easiest way of getting started with scenario planning is the classical worst-case/best-case method. This means that you primarily work with the revenue and then experiment with how you need to act depending on different scenarios. For example, if the income is 10% lower than the goal in April, how should we act with recruitment and other factors? If the revenue instead is higher, should we use this to our advantage and recruit more people?
Creating a worst-case and a best-case scenario and comparing these two results in a higher quality of the financial forecasting. This also means you get more thought-through plans for acting depending on which scenario plays out.
Dare to challenge and question
Have you succeeded with the above? Getting to a completely agile financial scenario planning isn’t far away. You’ve created the right conditions to work with scenario planning, where you constantly challenge, question, and update your assumptions. The advantages of getting here are considerable since you can then be prepared on how to act, and react, while optimising the business through better and more proactive decision-making.
There’s no exact science for how to get started with scenario planning. The most important part is to find a reasonable level for you and your process, and to create the right conditions. Are you interested in getting started with scenario planning? We’d love to have a discussion on how you can simplify and complement your financial planning with scenario planning efficiently. Feel free to contact me or a colleague, and we’ll take it from there.