We’ve talked before about scenario planning vs more traditional planning and want to expand on the different approaches to this method.
What do we mean by scenario planning?
As previously defined, scenario planning is a thinking method that identifies a specific set of uncertainties and considers the alternative future realities they could bring about. These potential events are assessed for their likely impact on the company in question, providing analysts with likely outcomes and tangible data based on a range of assumptions.
Within this, there are three main variations on the overall approach: scenario analysis; sensitivity analysis and what-if analysis.
Businesses will rarely adopt just one of these methods; your FP&A team will likely want to use elements of all three at various points in their planning processes. The ease of being able to mix approaches in this way is often inextricably linked with the capabilities and flexibility of the financial models sitting underneath.
This targeted approach involves applying changes to a single key driver in order to identify the impact of that variable on the rest of the model. This method can be enormously valuable in thinking about the allocation of effort and resources within the business, both in mitigating risks and also acting on opportunities that affect the driver in question.
Looking at a wider range of influences, scenario analysis considers a number of inputs and alters the value of each according to specific scenarios. This is most useful when considering possible external factors having an impact on the business. To give an example, considering the impact of a global crisis like COVID-19 on a supply chain involves adjustments to stock availability, delivery times – which in turn leads to impacts on service levels and sales – and exchange rate volatility.
Here the aim is to answer the question: ‘what if we did this?’ This often combines running both scenarios and sensitivities in order to test the situation you have created.
Powerful decision-making tools
Scenario planning is an important activity when looking to insulate any business against risk and identify potential opportunities. Through following these approaches, your FP&A team can recognise and come to understand both the worst– and best-case possibilities and then move forward with planning the relevant actions to mitigate against the negative and take advantage of the positive. Using the available scenario planning tools opens up greater access to valuable insight and allows your business to be more proactive.
There is no crystal ball
At this juncture it’s important to sound a note of caution and remind you that scenarios are ‘best estimates’. The strength of these predictions relies heavily on the accuracy of the assumptions in the underlying model. The more complex the model becomes and the greater the number of variables that are adjusted, the greater the risk of creating an artificial view of the future.
Keep it simple
When looking to the future, it is impossible to predict every variable in minute detail. Overcomplicating your analysis by changing too many drivers can create diminishing returns. Your team will no doubt generate interesting data and it might provide food for thought, but the more tinkering that takes place, the more your certainties are reduced. If this fact isn’t kept firmly in mind and planning isn’t carefully managed then the resulting roadmaps can end up being created based on pure conjecture.
Some of the best-managed and most effective scenario plans we’ve worked on with our clients have been as straightforward as a worst-case view and a stretch version of the working forecast. Sensitivity analysis is used to identify the level of change in key drivers and what-if analysis is employed to set the wider parameters.
The value of powerful analytical tools
No matter how simple the analysis your team is undertaking, having access to the right tools for the work can make all the difference. Having true data and real impacts readily accessible for manipulation through multiple dimensions in a system like Planning Analytics vastly reduces the time and energy required to perform this analysis. This in turn places your finance function in a better position to support your business with value-added analysis, driving profitable insight and working in a more collaborative way across your organisation.
To talk more about our suggested approach to scenario planning with Planning Analytics, get in touch today.