As the wheels of the world turn faster and faster, the need to experiment with your financial assumptions and your financial forecast increases. In order to meet this need, you have to be able to work quickly and efficiently with your scenario planning. By doing so, you’ll have a plan for how the business should act in different situations and you’ll be able to experiment with internal and external factors to analyse what effect different decisions and events might have on the financial forecast.
In this article, I’ll talk about scenario planning, highlight the importance of working with scenario planning, and I'll give you 6 tips on how to create a more efficient process for scenario planning in your business.
Scenario planning can be summarised as a financial method to identify possible 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 prices and payment terms – how might this effect the customers and sales? Or what if the currency drops by 10% at the same time as inflation drives up the costs and salaries? How will this effect the cash flow? Should we pull the brake and stop recruitments, or is the best course of action to keep going as planned?
Most companies do work with scenario planning in some way, but this often entails a lot of time-consuming manual work for the finance department – if you don't have a modern software for financial planning that is. For some, it might still be easier though to do scenario planning the old fashioned way with a few people from the finance department, but for most companies, getting input from the rest of the organisation is both relevant and necessary in order to increase the quality of the budget and in order for managers to understand the effect of different business decisions.
In contrast to the budget which often works as a framework for the business, the purpose of scenario planning is to challenge this framework. Your business should always know how to act when different scenarios occur in order to make the best possible decisions.
There's no denying that scenario planning can be time-consuming. That’s why you must think through your goals and optimise this work process. If you succeed, working with scenario planning might help you:
I also dare to say that you both increase your resistance and, since you've prepared for various outcomes and possible futures, you also gain an advantage over your competitors that don't work efficiently with scenario planning. By having a solid and efficient process for scenario planning, you can look over all of your alternatives and be prepared for how to act and when, which reduces the risk of “panic” and poor decision-making when a crisis arises.
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 a lot of manual labour and poses a lot of challenges that can stop you from going the distance. You need automation and complex drivers to succeed. These tools have become more and more accessible and during the past turbulent years and it's become evident that those working with a dedicated system for financial planning have better conditions for working continuously with their financial planning, which is a great advantage if you want to implement an efficient work process for scenario planning.
Identify the most critical drivers for your business. You’ll need these drivers to work parameter-driven and to be able to make assumptions and changes that instantly impacts the entire financial outlook. For example, what happens when we change our prices by 10% – how will this affect the income growth, costs and in the end, the cash flow? What effect will this have if you add sales representatives to a department or alter the assumptions for salary increases?
To succeed with scenario planning, you’ll need a solid driver-based process that builds up your entire P&L and balance sheet forecast.
The amount of available data continues to grow and without the correct data, it’s impossible to work in an agile manner. 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 which enables you to make more qualified decisions based on the correct data and assumptions.
Examples of data include sales volumes, head count, salary data, historical accounting data etc.
If you do not already have a dedicated system for financial planning, you’ll need to identify which systems that can be customised for and support your business. A system that streamlines your entire financial planning process and allows you to work data- and parameter-driven is necessary to quickly and efficiently test and evaluate different scenarios.
Take advantage of the system to automate parts of the process so that you can minimise the time spent on preparing and administrating new forecasting scenarios.
You need to decide on a reasonable level of involvement from the rest of the organisation., Where in the organisation are the insights needed to build up a qualitative forecast? 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 doesn't need to be involved in all scenarios, but if you’ve created a driver-based process with a high degree of automation, you won't be limited by the how many people you can gather input from.
The easiest way of getting started with scenario planning is the classic 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 regarding recruitment and other factors? If the revenue instead is higher, should we use this to our advantage and recruit more employees?
Creating a worst-case and a best-case scenario and comparing these two outcomes will increase the quality of the financial forecast. This also means you get more well thought-through plans for how to act depending on which scenario plays out.
Have you succeeded with the above? Then getting a completely agile scenario planning process 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 with 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.
Planacy's planning platform is fully customisable for your business, your processes and your needs – no matter your industry.
