Scenario planning or scenario modelling guides leaders in foreseeing possible outcomes, assessing responses, and navigating positive or negative situations. It empowers businesses to proactively prepare for risks and opportunities rather than merely reacting to events.
Scenario planning is like preparing for different outcomes in a video game – you strategise for different challenges. For start-ups, it’s vital because it helps you face uncertainties head-on. Imagine having backup plans for different situations – that’s scenario planning! It ensures you’re ready for whatever comes your way, be it tough times or big opportunities. Curious how it works and why it’s a game-changer for start-up survival? Several templates and structured frameworks exist for scenario planning, which we’ll explore. What matters most is selecting an approach that suits your team’s needs.
The Power of Scenario Planning in Finance
In the realm of finance, it’s essential to possess tools that are both powerful and flexible to navigate the consequences of rapidly changing business conditions and the uncertainties inherent in long-term financial forecasts. Many finance departments employ customised spreadsheets for financial modelling and impact analysis of these projections.
However, these tailored spreadsheet solutions are often challenging to manage, prone to containing opaque and unreliable data, lack integration with operational strategies, and fall short in handling treasury and financial modelling tasks. Running a business inherently involves a certain level of risk and uncertainty. While businesses might ideally experience smooth growth, the reality, as most founders can attest, can be quite different. This is where the significance of Scenario Modelling comes into play. Scenarios encompass potential outcomes for a company based on diverse assumptions and variables. Users of scenario planning have the capability to construct an array of distinct scenarios for each business unit. Additionally, they can assess the sensitivity of these scenarios to key performance variables and engage in recurring “goal-seek” evaluations.
Rather than relying on a single prediction for start-up survival, scenario planning examines a spectrum of potential situations. Even when structured data about future performance is lacking, as is available for past performance, inputs and scenarios can be employed to identify potential trends that might unfold over the upcoming years or decades. Compared to traditional forecasting methods, scenario planning for start-up survival holds a clear advantage. By crafting plans tailored to specific scenarios, businesses can future-proof themselves. Importantly, scenarios should be based on realistic events rather than extreme nightmares or unattainable goals.
Four best ways for optimising the benefits of scenario planning:
Incorporating Diverse Data: Agile planning by the strategic finance team requires comprehensive data beyond the general ledger. Access to company-wide data provides a holistic view of the business and enhances inputs, drivers, and outputs for scenario models. This data might encompass real-time, company-wide information such as sales volume data from the Customer Relationship Management (CRM) system, headcount data from the Human Resource Information System (HRIS), historical data, and the latest actuals from the General Ledger (GL), among others.
Selective Variable Choice: Effective scenario modelling should be built on a focused set of levers and performance indicators, similar to the budgeting process or dashboard reporting. Opt for a reasonable number of levers for scenario modelling. These levers, which should be within your control, allow confident forecasting of a wide range of potential outcomes. Common levers for evaluation, considering the challenges businesses currently face, might include sales volume, headcount, and available cash.
Plan for Multiple Scenarios: For each variable you intend to model, consider three primary scenarios: high, low, and medium (representing business as usual). It’s vital to make these scenarios significantly distinct from one another. The best-case scenario, portraying a thriving company, should be genuinely optimistic. In contrast, the low scenario should reflect substantial challenges. The medium case should represent a middle ground, reflecting operations continuing as planned without major market shifts.
Breakeven Analysis: Conducting a breakeven analysis showcases what’s required for each variable to maintain its current performance level. While finance teams have access to various tools and decision-making models during uncertain times, a breakeven analysis offers a straightforward way to assess financial conditions in any circumstance. Whether using Excel or a more advanced FP&A system, a breakeven analysis helps face the financial realities of product viability or business sustainability when time is of the essence.
How Scenario Planning is Conducted:
Problem and Choice Definition: Clearly define the issue and the decisions that need to be made.
Variable and Data Identification: Identify critical variables, trends, and uncertainties that can impact the plan. This involves gathering data from both external sources (economic changes, political climate, competitive challenges, consumer behavior) and internal factors (core competencies, growth potential).
Scenario Planning Template: Develop a template for scenario planning, often utilising a financial model. This allows the input of different assumptions and analysis of their effects on key metrics such as revenue or net income.
Scenario Creation: Develop scenarios, including base, worst, and best-case scenarios, as well as additional ones as needed. Involvement of individuals with relevant knowledge from across the organisation ensures a comprehensive perspective on potential scenarios and assumptions.
Scenario Analysis: Analyze the different scenarios, examining their potential effects.
Plan Development: Utilise the scenarios created in planning and assessing risks and rewards.
By adhering to a rigorous approach in scenario analysis, organizations can concentrate on the most critical scenarios, consider relevant factors, and maximize the process’s benefits. Scenario planning equips businesses with a competitive advantage, enabling swift and decisive responses. Thanks to careful consideration and the documentation of potential outcomes, there’s no need to rush when crises arise. The main strength of scenario analysis lies in its comprehensive exploration of potential situations. This allows management to evaluate options, comprehend the potential impact of variables, and identify potential risks.
In a world characterised by uncertainty, scenario modelling emerges as a powerful tool to navigate complexity, enhance preparedness, and make informed decisions that drive long-term success. We’ve empowered 100+ startups to succeed through strategic risk management. Partner with us to handle financial intricacies while you concentrate on business growth.
