Scenario analysis is crucial for exploring possible financial outcomes based on different factors. As it is, the financial performance of every business is reliant on various inputs, such as operational efficiency, product or service demand, supply chain factors, pricing models and economic factors.
With the business environment being an ever-changing one filled with uncertainty—especially these days—conducting regular what-if scenario analysis will allow you to see how different internal and external inputs might cause business key performance metrics to change so you can help your business make proactive planning decisions that account for a range of possibilities—both positive and negative.
Businesses that can identify how different scenarios might impact business performance are more likely to successfully navigate sudden events. As the World Economic Forum says, “Scenario planning can help companies prepare for future challenges and uncover new opportunities for innovation”.
Here are a few reasons why you should adopt regular scenario analysis to drive decision making.
More Effective Risk Management
Effective risk management means taking a proactive approach to identifying, analyzing and mitigating unfavorable outcomes. Now more than ever, we’ve seen how heightened uncertainty can pose a significant risk, disrupting business operations and driving downward performance. Examples of risk factors that can impact a business’s performance include regulatory risks, economic risks, financial risks, supply chain risks, etc.
With scenario analysis, you can model possible outcomes driven by varying risk factors to understand what the overall impact might be on your business. Here are some probing questions you could consider asking in your analysis:
- What if interest rates increase? How does this impact our borrowing costs?
- What impact does inflation have on our supply costs and accounts payable?
- What happens if the government tightens export or import regulations for certain industries?
- How do industry growth rates affect our key performance indicators (KPIs)?
Planning out different scenarios based on possible changing risk factors helps drive more effective decisions. Your business leaders will benefit from understanding the possible variations to the best possible outcome through what-if scenario planning.
Proactive Financial Planning
While the future cannot be exactly predicted, an effective financial plan gives a realistic representation of overall financial performance driven by certain assumptions.
Scenario planning lets you explore how different scenarios drive possible outcomes. A single scenario can involve multiple inputs, such as operational efficiency, personnel expenses, occupancy costs and sales orders.
A base case scenario can adapt the most likely assumptions to model the financial performance under that scenario. A worst-case scenario, on the other hand, will explore more unfavorable assumptions and how they impact the financial performance of a business.
By providing business decision makers with ranges of possible financial outcomes, from positive to negative, what-if scenario analysis gives them the tools they need to make proactive—rather than reactive—decisions, as they can see a clearer picture of the business’s financial performance based on varying assumptions.
Tracking profitability metrics is essential to the success of every business. Key decisions are made based on possible KPIs, such as total revenue, gross profit margin, operating income, net income margin, return on capital invested, net present value and so on. Scenario analysis helps you analyze different KPI outcomes so your business can better navigate uncertainty—both now and in the future.
Overall Business Planning
A lot of industries generate big data that needs to be stored, retrieved and analyzed when required. Leveraging a planning platform that consolidates data from across your organization into a central database is key to effective data organization. Taking this one step further, automating the process of populating that data into Excel will make for faster, more efficient scenario analysis and better overall business planning.
The ability to enhance scenario analysis in this way is critical for successfully navigating your industry’s current business climate. You will be able to effectively test your business plans against a variety of different scenarios to make more informed decisions as to how condition changes in the market will affect your bottom line more accurately.
The current business environment calls for agile forward-thinking practices that allow you to adapt to change more readily using real-time data. Through comprehensive scenario modeling software, such as Vena Complete Planning, you can plan for the future with more confidence.
Business Opportunities for Growth
More often than not, relying on a single financial forecast can limit a business’s view on possible opportunities for growth and expansion. Scenario analysis creates an avenue for business leaders to see how alternative decisions can drive growth.
For example, a what-if scenario analysis for increased manufacturing production can lead to higher rates of internal growth, potentially spurring even better business performance. By mapping out several paths, production departments are able to understand the importance of increasing efficiency in order to drive better bottom lines. In turn, the sales team can gain insights into how higher orders impact business revenue and overall profitability so they can better develop sales strategies.
Ultimately, when scenario analyses are done accurately, you’re empowered to make better decisions that drive business growth. Accounting for multiple possibilities based on different assumptions enables teams to identify opportunities for innovation, reframe strategies and find novel ways of maximizing efficiencies to achieve the best possible results.
Best Practices When Using Scenario Analysis for Decision Making
Using the right tools for planning and analysis is critical for effective decision-making. To make better financial and business decisions, the following best practices can be adopted:
- Explore possible assumptions and scenarios for business operations
- Engage effective financial planning tools and technology
- Use historical data and predictive analysis for better results
- Promote interdepartmental collaboration for more agile solutions
With the right technology and spreadsheet integration, scenario planning and analysis can help your business make beneficial decisions. It is a great tool that can help explore the possible outcomes when varying drivers are applied to business financial models.
The what-if analysis process is at the heart of business planning. While no business has exact predictions of what could occur in the future, scenario analysis with Vena’s easy-to-use platform can help provide predictive insights on possible future outcomes. This ultimately allows your business to mitigate risks, explore growth opportunities and generate a healthy bottom line.