The global economy is going through tumultuous times. Most markets are volatile, saturated, and unstable, and have been for quite a few years.
Although inflation has fallen significantly since it hit 11.1% in October 2022, it is still something that businesses need to be careful of. This rise and drop shows just how fluctuating and challenging economic changes can be for a company.
So, how can today’s businesses secure long-term health? One way to achieve this is through financial scenario planning. This approach can prove very helpful when it comes to strengthening the finances of a company during uncertain times.
To learn more about this topic, keep reading our guide on scenario planning.
Key takeaways:
- There are many ways you can use scenario planning to make more secure financial decisions.
- Using the right scenario planning tools can help you create accurate plans that use key KPIs and other financial data.
- You need to measure financial performance before identifying ways to improve.
- There are many benefits to using scenario planning in times of uncertainty, including better decision-making, lowering risk, and becoming more flexible.
- You need to be aware of the challenges that come with scenario planning.
What is Financial Scenario Planning?
Financial scenario planning is the process through which businesses try to predict the outcome of changes to a business’s finances or how external forces will impact them during uncertain times using both assumptions and data.
This is a powerful tool that enables companies to create best-case and worst-case scenarios. Estimating cash flow and predicting financial earnings are the two most important things that businesses scenario plan for, but it can measure any metric that’s important for them. For example, anticipating how well a new outbound call center solution will work and impact the profitability of a business, is a more detailed nuance of financial scenario planning.
Understand the Different Types of Financial Scenario Planning
There are different types of financial scenario planning. Below, we discuss the four most common ones.
Operational scenarios
One of the most common types of scenarios that a business will undertake, operational scenarios explore the immediate impact of an event and look at the short-term implications.
Quantitative scenarios
These scenarios are used for financial planning and budgeting. They look at financial variables and produce reasonable outputs. The variables can be changed quickly depending on the situation or if the financial team wants to look at an alternative scenario. This is typically done anyways in budgeting and forecasting, but
Strategic scenarios
Strategic scenarios are based more on the environment in which services and products are consumed than the business or industry. These can be quite challenging to put together, as they need a broad economic, world, and industry view. To build these, businesses often require the intervention of external experts and analysts. An example of this is anticipating changes to global trade due to political environments. On a more local level this can be scenario planning based on weather. Ex: A winter with less snow means less foot traffic to restaurants near ski resorts.
Normative scenarios
These scenarios look at a preferred or achievable end state. They are much less objective and look more at goals. They are often about how a business would like to operate in the future. Normative scenarios also help companies develop roadmaps to achieving their goals and outline their future organizational performance.
The Benefits of Using Financial Scenario Planning
If you are going to use financial scenario planning for your business, you can expect to reap the benefits listed below.
Better decision-making
Scenario planning provides business owners with multiple options, enabling them to make more informed strategic decisions. It gives them valid reasons for the decisions they make and helps them determine what resources they need for these decisions.
Lower risk
Scenario planning focuses on creating backup plans and looking at the worst-case scenario. Therefore, identifying and avoiding risk is a standard practice in business planning. By knowing how to act to reduce the impact of a harmful scenario, you can lower risk and become a more resilient, adaptable business.
Flexibility and adaptability
When using multiple scenarios, businesses can pivot and make amendments when needed. They don’t need to start from scratch or rush to fix an issue. This helps a business keep its operations going regardless of what happens.
Contingency planning
When done correctly, scenario planning enables businesses to create contingency plans for unforeseen circumstances. These are essential for risk management and can help businesses navigate challenges with agility and confidence.
Collaboration and communication
Scenario planning needs insights and input from all areas of a business – not just the accounting and financing department. Teams will become more aligned when creating scenarios, as they need to communicate and collaborate when making important business decisions.
Strategic balance
When working with financial scenario planning, business leaders can identify which plan aligns with their broader business plan. This means they can focus business decisions on one overarching end goal across all departments of the business.
Accurate forecasting
When a business looks at multiple outcomes, it can forecast future finances more accurately. Financial scenario planning enables companies to look at key drivers of change and consider numerous potential futures.
Best Practices for Successful Financial Scenario Planning
When it comes to financial scenario planning, you need to follow a series of best practices. These will help to ensure you are creating plans that are accurate, adaptable, and useful. Here are some tips to get you started.
1. Use Scenario Planning Tools
Financial scenario planning can be a complex thing to get right – that’s why you should use some specific tools to make it easier.
CRM software
CRM (customer relationship management) software has real-time data on customer behaviors and preferences that help businesses make informed financial scenario plans. It can enable a company to test and model scenarios and look at the impact they may have on customer relationships, sales pipelines, and revenue forecasts.
Risk management software
This software can help identify and assess risks that can be used to measure the specific risk that may stem from various scenarios. It’s a good tool when you want to develop action plans to minimize the potential dangers linked to different scenarios.
Financial management software
You can use financial management risk software to analyze and monitor your business’s economic stability and position; this will enable you to make predictions about future performance based on historical records. Using software like this, you can create budgets, forecast cash flow, and scenario plans.
2. Keep your accounts up-to-date
Your accounts must be completely up-to-date in order for scenario planning to be effective. If you work with outdated data, the plans you create won’t provide you with an accurate solution. Look at your past and current account information and use it to make financial scenarios using only the most accurate information.
3. Define Key Issues
One of the first things you need to do is identify the key issues that could potentially impact your business with future changes. Whether they are technological, political, economic, or legal, when you analyze these scenarios, you can better prepare yourself to manage them if they were to happen.
Ask yourself these questions:
- How far ahead are we trying to predict?
- What are the risks of each scenario?
- What is the uncertainty that we are trying to assess?
- What are the key internal factors we need to address?
- Do we have accurate data, bandwidth, technology, and skills to create scenario plans?
In order to define the key issues, you need to recognize important uncertainties. Some events may have a bigger impact than others on your business. For example, there may be economic changes that could impact business performance in your specific region, that you might not need to consider if you were located elsewhere.
As a way to plan better and analyze performance, you could use driver based planning and rolling forecasting. When you define the key issues your business may face, you can use this as a building block to build a financial plan to predict the best-case and worst-case scenarios.
4. Create Multiple Scenarios
One of the best things about financial scenario planning is its ability to provide you with multiple outlooks for your business. When you create multiple scenarios, you can ensure you are protecting your business in uncertain times and are fully prepared for growth.
Considering so many possibilities can be a little daunting. However, you can limit this by keeping scenario planning simple. You can do this by:
- Clearly defining assumptions: You need to use historical trends, opinions from experts, and market research to create clearly defined assumptions. You can then leverage them with uncertainties to create a scenario that is based on realistic expectations and outcomes.
- Creating only two to three scenarios: Although it is good to create as many scenarios as possible, it is also best practice to focus on two or three at a time. If you are working with too many, you can lose sight of the predictions and struggle to make financial decisions.
- Understanding implications: An essential part of scenario planning is understanding the implications it can have for your business. Once you know how a scenario can impact your business, you can use it to build a plan to protect your business that aligns with your short-term and long-term goals.
5. Manage Your Scenario Planning
Once you have started to use scenario planning, it is important that you put the steps in place to manage and monitor the process. Frequent changes in data might mean that you need to keep revising your plans while, at the same time, managing it as smoothly and efficiently as possible.
6. Create a flexible response
It’s not possible to perfectly predict future outcomes. Therefore, you need to be agile and ready for change through a flexible response plan. When you have a plan in place to alter a business plan or diversify product lines, you should be prepared for sudden and unexpected U-turns, depending on the data you are presented with.
7. Recognize the Challenges of Scenario Planning
Just like in most areas of business, scenario planning comes with its fair share of challenges. It’s best practice to make sure you are aware of them, so you can use scenario planning to its full potential.
External factors
You need to ensure you are focusing on internal business drivers more than potential external factors. It can be easy to hyper-focus on external factors, but you also need to look at operational efficiencies, organizational structures, and employee performance.
High level of resources
Scenario planning involves a high level of resources, as multiple plans are often needed. If you do not have a dedicated team that maps out the different outcomes, you need to make sure you are using tools like cloud integration software so the people who need to access files can do so anytime and anywhere.
Uses assumptions
Some businesses avoid scenario planning because it’s only hypothetical. While, on the one hand, it leverages data and historical trends, on the other hand, it also relies on assumptions that may not reflect reality accurately.
Complex decision-making
When faced with multiple plans that are developed through scenario planning, it can be challenging to choose the right path. This, though, can lead to businesses being unable to make decisions or companies planning for scenarios that never happen. It’s best to slow down and come up with specific decision-making criteria to help you come to final decisions.
Overlooked scenarios
Scenario planning isn’t foolproof. Even businesses that follow all the best practices can be left facing unforeseen circumstances. For instance, think of the outbreak of the Covid-19 pandemic. It’s important to remember that it’s impossible to predict all scenarios; instead, you need to be prepared to adapt and respond.
Continuous monitoring
Scenario planning isn’t something that you can do once and leave; it is continuous and, therefore, requires constant monitoring. And even though your financial experts will be at the core of the process, it’s is best to have a broader team, with professionals handpicked from other departments, such as marketing and sales.
8. Build best and worst-case scenarios
Some businesses fall into the trap of only planning the best-case scenario; however, it is even more important to look at the worst-case scenario, too. Best-case scenarios are great for looking toward business growth, but when it comes to seeing the whole picture, the worst-case scenario will provide a business with the right starting point. If only the best case is looked at, a company would need to backtrack any plans and constantly underachieve. This is often done by conducting what-if analysis as this helps finance teams break down the best and worst-case scenarios.
9. Define the scope
A financial scenario planning team needs to be on track with the key focus areas of the business, which means that the planning scope needs to be clearly defined. You can achieve this by:
- Setting clear objectives
- Identifying focus areas
- Prioritizing key uncertainties
- Building a flexible scope
- Defining the scope boundaries by setting limits on time, location, demographics, etc.
Conclusion
Financial scenario planning is an extremely helpful tool and an essential practice for businesses that want to manage uncertain times properly. By implementing the best practices outlined in this guide, you can better anticipate any potential challenges, maintain flexibility in your business planning, and make informed decisions.
Whether it’s creating multiple scenarios, using the right tools, or defining key issues, effective financial scenario planning will enable your business to be prepared for what the future holds.
