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As a finance professional or business owner, scenario planning plays a big part in the future success and well-being of your organization. For this reason, it's critical to understand the ins and outs of scenario planning, ranging from why it's important to the tools you can use to complete the process.
Scenario planning is a method of financial planning with which you mitigate future risk by identifying assumptions and determining in advance how your company will respond.
For example, projecting estimated future cash flow allows you to plan for all scenarios, including both an increase and decrease.
Scenario planning can be completed across your entire company or within individual departments. For example, finance departments often run scenario planning on their own. However, there are times when they'll collaborate with other departments to better understand the potential impact of business decisions, such as expanding a product line.
Scenario planning helps organizations adapt and be prepared for change. Scenario planning gives executives and business leaders insights into different situations an organization might find itself in. Being able to plan for different scenarios enables executives to make decisions more effectively.
It's been said multiple times in this guide, but it's worth mentioning again: the scenario planning steps that one company takes won't be identical to the next company. Don't make decisions based on what your competitors are doing. Make decisions based on what's best for your organization.
Here's a four-step scenario planning structure to help guide the process:
This varies from company to company and from model to model. Identifying the questions you want to answer sets the table for the steps to come. Common questions include:
Even if you start with a list of defined questions, your approach could change as you get started. You may find that there are additional questions to address.
The first question to answer is this: Does scenario planning involve your entire company or only one (or several) departments?
Once you answer that question, you can more easily determine who to involve. Even in the smallest of companies, scenario planning isn't generally a one-person task. It takes several individuals--or more--to manage and carry out this process.
Scenario planning isn't all about what's happening internally. Sure, this is a big part of the process, but you should also consider external factors. These can include details such as:
While you have control over what happens internally, external factors are likely to come into play over the long run.
There are four general types of scenario planning:
You can't get started with the actual scenario planning process until you know which type you're using.
Tip: don't force yourself to take steps that don't align with your company, its goals and/or the resources available to you. These four steps can act as a framework, but make adjustments as necessary.
Also, scenario planning provides an advantage over the competition as you're able to react quickly, concisely and decisively because you already have a plan. You've thought through your options and documented them accordingly. This reduces panic and poor decision making should a crisis move to the forefront.
This is a legitimate question that you need to address before getting started.
There's no one-size-fits-all solution to scenario planning, but there are four distinct types to consider:
Normative scenarios focus primarily on the statement of goals, as opposed to objective planning. These goals don't have to correspond with your company's vision. Instead, they're based more on how you want to operate over the short and long term. On its own, normative scenario planning isn't as powerful as some of the other types. However, when combined with other scenarios, it's a solid choice.
Operational scenario planning is one of the most common types of scenario planning, as it touches on the direct impact of a specific future event. It allows you to better understand strategic implications and to plan accordingly.
It often helps to look at future situations from a best and worst-case point of view. And that's exactly what you get with quantitative scenario planning. It also allows you to make quick adjustments by altering a variety of variables. This form of scenario planning is most common when creating budget forecasts.
This type of scenario management focuses less on the company itself and more on the manner in which products and/or services are used. This is among the most challenging types of scenario planning as you must have comprehensive knowledge of your industry, local and national economics and the global landscape.
It's a common misconception that scenario analysis and sensitivity analysis are one and the same. We've talked about scenario analysis and planning to this point, so let's dive deeper into sensitivity analysis. Here's a definition shared by Paro:
There are times when scenario analysis is all you need. The same holds true of sensitivity analysis. However, there are also situations in which it makes sense to use them both.
Don't go into scenario modeling with the mindset that you have to do things a certain way. This can back you into a corner, making it a challenge to maximize your efforts.
A better approach is to rely on best practices, all while taking your company's individual needs into consideration. Here are four best practices to guide you:
Without the right data, executing on agile planning is an impossibility. Sure, you could make educated assumptions, but that's not what scenario planning is about. Every decision you make should be backed by accurate data.
Some examples of data include sales volume data from your customer relationship management (CRM) software, headcount data, sales pipeline health and historical data.
You won't use every data point at your disposal, but it doesn't hurt to closely review it to determine what you can employ.
There are two things to remember here. First and foremost, you have to choose the right variables. Secondly, you don't want to overdo it.
For example, here's an excerpt from our best practices blog post:
"Identify your levers from all of the metrics at your disposal. Then start with the plan and execute with the budget or forecast. When making decisions about financing, operational changes and more, consider your values and strategic priorities. Then work to remodel your KPIs, business assumptions and expected business performance accordingly."
Just because you have a particular metric at your disposal doesn't mean you need to work with it. You need to choose the right variables at the right time.
This is based largely on the old saying "hope for the best, but plan for the worst." The only difference is that you're adding another scenario: status quo.
Your three basic scenarios should include:
The goal of break-even analysis is to determine what you need from each variable to continue performing at the same level. You can use it to answer questions such as:
Break-even analysis is a useful tool for scenario modeling as it can help you better understand your company's required performance in relation to the three basic scenarios as detailed in #3 above.
It doesn't matter if you're new to scenario planning or have gone through this process several times in the past, you may have questions. It's best to address any questions and concerns as they arise, to avoid future complications.
Here are 10 common questions associated with scenario planning:
Maybe some of these questions have been bogging you down. Or perhaps all of them have been on your mind. Even if you only have one or two questions to answer, address them as quickly as you can.
By now, it's our hope that you have a thorough understanding of all things related to scenario planning. With this knowledge, you can take the steps necessary to plan for any situation your company could face in the future.
And remember, there's no "exact science" to scenario planning. A lot of what you do comes down to the specific requirements of your organization. The more time you spend on scenario planning the more comfortable you'll become.
If you're ready to get started with scenario planning, contact us online to request a free demo. We'll walk you through our scenario planning and analysis software to help you better understand the way it can positively impact your business.
See how the decisions you make today will affect your bottom line tomorrow, with Vena.
As Senior Director of Content and Communications, Jonathan Paul leads content strategy and execution at Vena, overseeing the development of owned media and content experiences that help finance professionals fuel business health, as well as their personal and professional growth. When he's not dreaming up new ways to offer audiences value through content creation, Jonathan loves to lose himself in an immersive video game with a solid narrative, lose golf balls pretending to be good at golf and lose time dreaming about time travel.
