Scenario planning is a powerful tool for Financial Planning and Analysis (FP&A) teams –one that helps them anticipate and prepare for potential changes in the modern business environment. As businesses today grapple with increasing uncertainty from inflation, changing economic conditions and geopolitical forces, Finance must understand the range of potential scenarios that could await and how to react to them. By incorporating scenario planning into the budgeting and forecasting cycles, Finance professionals can improve forecast accuracy and the effectiveness of the financial and operational forecasts. Collectively, those improvements will better position the organization for success in a rapidly changing world.
Most people regularly perform scenario planning in everyday life without even realizing it. Deciding whether to bring an umbrella on a night out in case it rains or keep a spare tire in the trunk in the event of a flat time (or in my case, having roadside assistance since there’s no way I’m changing a tire!) are a few examples. These decisions represent scenario analysis. What is that exactly? Scenario analysis helps avert potential disaster (or a wet hairdo on date night).
For FP&A teams, scenario planning can be a powerful piece toolkit to help anticipate potential challenges and opportunities and then make better-informed decisions. That planning prevents Finance and operational leaders from always having to react in the moment to fire drills.
The basic concept of scenario planning requires identifying a range of possible future conditions and then developing plans to respond to each condition. This approach helps organizations be more resilient and adaptable. How? In short, they are better prepared to react to unexpected challenges and changes. FP&A can especially benefit from incorporating scenario planning into budgeting and forecasting processes. Doing so ultimately elevates the Finance function to the role of valued strategic business partner tasked with proactively driving financial and operational results within the business.
But how? To incorporate scenario planning into the budgeting and forecasting cycles, Finance should first identify key drivers of the business and then create a set of scenarios to account for possible changes to any of those drivers. For example, a manufacturing company might want to understand the potential scenarios where manufacturing costs per unit changes because of a change in the price of raw materials. In this scenario, three potential outcomes could be evaluated: (1) price increases, (2) price decreases, and (3) price remains stable. OneStream’s Analytic Blend (figure 1) capabilities can help enable effective scenario planning by tracking key operational analytics that form the basis of alternate scenarios.
As FP&A leaders prepare to take advantage of scenario planning to drive performance across the organization, the steps below will help begin the journey:
After identifying the KPIs such as weekly sales and volume, inventory carry costs, working capital and more, Finance can then craft potential scenarios and develop financial projections for each scenario. Those projections then help Finance not only better understand the financial impact to the budget and forecast, but also identify and track risks and opportunities as a metric against the forecast. In doing so, Finance then has the information to assess forecast accuracy and proactively drive the most favorable outcome –ahead of month-end close before the impact hits the actuals.
Beyond just the impact to the budget and forecast, FP&A teams can also help drive more strategic decision-making across the organization by weighing the financial impact of potential strategic initiatives. Such initiatives include acquisitions, divestitures, share buybacks, projects ranging from IT to CapEx, and more. By analyzing and providing a financial context to important strategic initiatives, Finance can be poised to earn a seat at the decision-makers table and become a valuable business partner to stakeholders and business leadership.
By driving the process of scenario planning and incorporating into day-to-day forecasting processes, FP&A can increase its organizational reach and improve agility in the face of uncertain times. Both collaboration and agility come with owning the process and bringing together stakeholders from Supply Chain, Operations, Marketing, IT and more to develop the various scenarios, outcomes and plans to react to those scenarios. Such planning therefore helps generate valuable discussion within the organization and prepares the organization for future situations.
In sum, scenario planning is a valuable tool that empowers the Office of Finance to not only improve the accuracy and effectiveness of the budget and forecasting efforts, but also become a strategic partner to the organization. By understanding possible outcomes and having a plan in place to react, businesses can be better positioned for success in a rapidly changing world.
No one can predict the future, of course. But Finance professionals who leverage a robust scenario planning process can anticipate and prepare for potential change, leverage opportunities before they pass and make strategic decisions that position the organization for long-term success.
To learn more about how Finance can become a valued strategic partner to the business, check out our Conquering Complexity in Strategic Planning solution brief.