These days, predictability is a rare commodity. Keeping up with all the changes that affect your industry, the economy, or customer habits is tough enough. Actually planning for them seems near impossible.
As finance professionals, we do the best we can, but unexpected events – like a cosmic snap of Thanos’ fingers – can change everything in an instant.
While we can’t go back in time like Tony Stark, we have the next best thing: scenario planning. With tech-backed scenario planning, you can do one better and avoid the crisis – or, at least, know exactly how to deal with it when it pops up.
Read on to learn the what, why, and how of scenario planning, and why it’s something no business can afford to do without.
What is Scenario Planning?
Scenario planning is a strategy employed by businesses to create responses to specific events. The Economist describes it as “a structured way for organizations to think about the future.” And, boy oh boy, can the future bring lots of changes. These changes might be small-scale – a disruption to a specific supplier or shifts in local demand – or large-scale – increased inflation or an economic boom.
How would your business weather these changes? Could you adjust to them in a way that optimizes your use of cash, and protects against risk? If your cash flow decreases, how long could you continue to pay creditors and employees?
Answering questions like these is the goal of scenario planning. You’re sort of like Dr. Strange when he considered 14 million possible futures – ok, it’s best to go through just 3 or 4 scenarios at a time, but you get the idea.
The goal is to anticipate the effects of changes before they occur so you have effective responses ready to be deployed – contingency plans. This way, you’re not scrambling to figure out what to do when an economic downturn snaps your revenue in half, or sudden regulatory changes throw a wrench into your operations.
Scenario planning evaluates just about every factor you can think of, including:
- Economic Changes
- Technological Developments
- Regulatory/Political Changes
- Geopolitical Events
- Industry-specific Changes
- Demographic/Customer Changes
Why Build Scenario Plans?
Well, there’s one obvious benefit: having plans for different scenarios. But there’s much more to it than that.
Building and applying scenario plans helps the company remain flexible, resilient. Even if the exact scenario isn’t likely to occur, running models can reveal valuable insights.
For instance, let’s say you see a disruption to Supply Chain A would be disastrous. You’ll probably realize your company relies on it too much, and decide to diversify your suppliers and lower your overall risk. Or, if you see a hypothetical increase in interest rates drastically impacts your profitability, it might be a good time to review your financing strategies.
In this way, scenario planning forces you to isolate the most important – and most vulnerable – components of your business. This helps finance teams make better decisions, choosing investments and operational activities based on how they interact with those components.
Scenario planning is something you want to implement into your workplace culture, not only when it looks like stormy waters are ahead (or when they actually hit!). It’s a different way of thinking that makes you recognize and question your assumptions.
Scenario planning means looking at things strategically, considering how all the different internal and external variables will interact and play off one another to affect your financial position.
Rather than focusing solely on the present, scenario planning focuses on the long-term, analyzing trends and asking how those trends will be affected by future changes. In this way, you’ll stay far ahead of the impact of potential, likely events – not to mention the competition, who might get blindsided.
How Do I Build Scenario Plans?
The scenario planning process can be broken down into a few steps.
The first thing you need to do is identify potential issues. Don your thinking cap – it’s time for some brainstorming. Are you in an industry that’s likely to be affected by future regulations? Are relevant technological changes occurring? Maybe AI is set to completely change your workflow, and you need to think about how you’d adjust existing jobs.
Next, you gather data. Record external data on trends, but also internal data. To build scenarios, it’s always a good idea to see how your business behaved in the past by analyzing historical data. You’ll also want to analyze cash flows – understand where cash is coming from and where it’s going, and get a handle on your current liquidity position as fast as possible (more on that later).
From there, you begin building your scenarios. For each possible scenario, consider what challenges and opportunities would arise. How could your business respond? If the change is a shift in customer behavior, you might need to develop new products or alter your business model. How much liquidity would you need to ride out a big decrease in sales of a popular product? Whether or not you actually implement the changes depends on how likely – and how threatening – the scenario is.
Finally, remember that scenario planning is not a “one-and-done” kind of thing – it’s an ongoing process. The business and forecast landscape changes all the time, and you need to put that new data into your plans as it emerges.
The process outlined above isn’t necessarily simple. That probably helps explain why so many companies don’t do scenario planning at all (or at least, not as often as they should).
Let’s go through the steps and show you what we mean.
The first is easy enough – you just need people in the company who understand how the business functions and know a lot about the surrounding industry landscape. Assuming you have that, you’ll be able to generate the likely scenarios.
But what about the second step – gathering data? Scenario planning is meant to be a fast, flexible process. Do you know what isn’t fast and flexible? The traditional methods of gathering and reconciling data.
If you work in the finance department, you’ll know exactly what we mean. Your company has potentially dozens of bank accounts, meaning you have to run from bank portal to bank portal, frantically recording data like Sonic the Hedgehog collecting rings (though at a much, much slower pace).
Once you have it, you must work on manual normalization and input. Only then can you actually build scenario plans off of it. All this effort takes time away from strategic analysis (for Crowdstrike, it was about 40 hours a month).
We’re only on step two, and we’ve already run into a problem.
As you might be able to tell from the heading, technology provides the solution – specifically, technology in the form of APIs. APIs allow third-party software like Trovata to communicate directly with banks. All transaction information is gathered automatically across bank accounts and displayed in one, centralized location. Reconciliation is a thing of the past as the data is automatically normalized. You get easy, fast access to high-quality data without even having to think about it.
To build scenario plans, you also need to be able to categorize data. Again, when there’s so much of it, this can be difficult.
Software can help. You can use different tags and streams to more easily sort through data and quickly find the relevant bits. You can also use user-defined growth rates and variables to automate forecasts.
Getting a Handle on Cash Flows
Every business depends on cash. If the purpose of scenario planning is to protect your business against risk, that really means it’s ultimately about preventing your company from running out of cash.
That’s why, when planning for a scenario, one of the first things you should do is establish how much cash you have right now. Only once you know that number can you determine how pressing a potential threat really is – how much wiggle room you’d have even in a worst-case scenario.
Once again, the way to do this is with APIs, which can allow you to know your cash position down to the day. The old way to do it involves adding up all transactions to your previous closing position – just about an impossible task.
The next thing you’ll want to do is determine how much cash you’d need to make it through that scenario. You can do this with targeted forecasts built on user-defined variables. Then, if the scenario is likely, you’d start building up your liquidity position to reach that target.
All this information helps you answer the question of how you can and should respond to each scenario. It shows you how to use what money you have most effectively.
Make Sense of Data with Machine Learning & AI
The final piece of the puzzle is machine learning & AI. Imagine having the ability to swiftly analyze data and adapt to changing landscapes – almost essential for effective scenario planning, right? While the old banking mainframes served their purpose in their heyday, they can’t keep up with the times, falling short in both flexibility and scalability. With the power of new machine learning and AI innovations, you can squeeze much more actionable information out of your data.
Keep in mind that scenario planning goes beyond the finance function – it’s a full ensemble performance that demands cross-departmental collaboration. As awesome as finance is, they won’t be able to understand customer psychology as well as the marketing team, for example.
By inviting all departments to the brainstorming stage, you’ll uncover challenges and opportunities that finance alone might overlook. When all data is centralized, everyone’s dancing to the same rhythm (no data silos).
Once finance has a clear picture – and how each department will react to these circumstances – they have a much better idea of how much cash the company will need to make it through the scenario. They also understand how critical each aspect is to the company’s security, what the most prominent threats are, and get new ideas for building scenario plans.
Bringing It All Together
Automated software like Trovata provides an end-to-end scenario planning solution. Don’t believe us? Let’s run through the process, starting with the transport layer.
Forget about downloading CSV files. All data across accounts is delivered to a centralized location, like trains moving into a hub.
Once data gets there, it’s automatically reconciled. You have access to the most current data – an absolute necessity when navigating unfolding real-time scenarios or planning for the what-ifs of tomorrow.
Then, machine learning comes in to give it that one-two punch, revealing insights that no human could uncover (or at least not as quickly). You have information you can act on, not just collate.
You know your liquidity position right off the bat, so you understand exactly how long you have to make adjustments before running into problems. It’s like having a financial crystal ball that not only shows you imminent threats, but also advises on the next move.
Case Study – Navigating the Pandemic With Scenario Planning
If there’s any one event in recent memory that showed us we can’t expect financial conditions to always remain the same, it’d have to be COVID-19.
Businesses that did invest in scenario plans were better able to ride out the storm – even thrive. They could quickly source alternative suppliers, and shift gears from brick-and-mortar to online offerings. Acute awareness of their cash flow – both inflows and outflows – further guaranteed their stability.
The pandemic came on like a whirlwind. Businesses that did not have a solid scenario-planning process were not able to respond as quickly, and were not able to build up their liquidity positions. Many had to slash capital expenditures by 25 to 30% just to keep their doors open.
Imagine if those businesses had been able to see the effects of their moves in near real-time. Imagine if they had considered the possibility that their current situation might not continue indefinitely. Instead of grappling with outdated, spreadsheet-based insights, they could have made timely, informed decisions.
Leverage Present and Future Insights Today
Given the past few years, it’s fair to say scenario planning is no longer a luxury – it’s a necessity.
But to actually do it in a way that makes it leverageable – that makes it possible to react to crises on a dime – you need tech that provides data and cash visibility. Otherwise, you’ll be bogged down in spreadsheets, “figuring out” the situation rather than responding to it.
Get started with Trovata today – book a personalized demo.
Scenario Planning FAQs
What is Scenario Planning?
Scenario planning is a process that plans responses to a variety of changes that could affect your business: economic, regulatory, technological, etc. More than that, though, it helps you determine which areas of your business you depend on most, and how each affects the others.
How Does Scenario Planning Work?
Scenario planning involves identifying potential issues, gathering and analyzing relevant data, and building models that examine how different variables – say, increased regulation of your industry and product prices – affect one another. Based on that information, you’d create a plan to implement if the scenario is likely, or comes true.
How Does Scenario Planning Differ From Forecasting?
Forecasting mostly assumes that current trends – both large-scale and small-scale – will remain the same. Scenario planning tempers this expectation by showing you how things would go if one or more factors changes in the future.
What’s An Example of Scenario Planning?
Say your company produces environmentally-friendly light bulbs. You might project how increased government subsidies would boost your bottom line. Alternatively, you might project a situation where competitors are able to greatly reduce their costs through new processes – how would you adjust?
What Tools Can Help with Scenario Planning?
Since scenario planning depends on solid data, automation tools – especially those that utilize APIs, like Trovata – can help ensure the data is accurate and timely. Other options include running industry surveys, using classic methods like SWOT or PESTEL analysis, or conducting workshops.