the advantages of scenario planning and

Applied Financial Intelligence

Axiom EPM:

The Advantages of Scenario Planning and how to implement it effectively

Finance leaders no longer can rely on one-dimensional projections in planning for their organisation’s future. They need the ability to quickly change course in response to shifting market or environmental forces.

Scenario planning is a method of strategic financial planning that enables finance leaders to mitigate risk and prepare for the type of volatility that is an increasing and all-too-common reality. It accounts for inherent future uncertainties by quantifying the financial and operational implications of change, and analysing a range of possible outcomes to facilitate proactive strategic planning.

Scenario planning is an essential tool for any organisation in today’s turbulent environment. Yet, recent Axiom1 surveys across multiple industries found that only about 50% of organisations planned to include scenario planning in their financial planning and analysis initiatives for the upcoming year.

From global pandemics to economic downturns and ever-evolving competitors, uncertainty has become the norm across nearly every industry.

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Introduction

These results suggest that too many finance leaders continue to use traditional annual budgeting and forecasting methods that focus on a single scenario. Such methods are increasingly outdated, resource-intensive, and time-consuming. According to the surveys, more than two-thirds of organisations have a budgeting cycle of three months or more. The end product of those months of work often yields static budget projections that quickly become irrelevant in the face of unforeseen changes.

This type of tunnel vision can be dangerous. It puts organisations at a significant competitive disadvantage by severely limiting their ability to flex their strategic planning in response to changing dynamics and can help push them toward financial instability or failure.

1Syntellis: 2021 Higher Education Financial Technology Trends. Syntellis Performance Solutions,

2021; 2021 Financial Institutions Finance and Technology Trends. Syntellis Performance Solutions,

2021; 2021 Healthcare Financial Trends Report. Syntellis Performance Solutions, 2021.


Consider new possibilitiesBe better prepared if adverse circumstances should manifest

Produce higher quality strategic plans, budgets, and forecasts

Treat financials primarily as outcomes instead of inputs

More effectively manage risk and uncertainty

Test a strategy’s strength and flexibility under adverse or changing conditions

Reduce or eliminate bias or aspirational thinking that is not grounded in reality

Quantify the organisation’s sensitivity to key drivers

Understand and define key drivers of organisational performance

The Advantages of Scenario Planning

Scenario planning is a powerful learning tool that helps finance leaders better understand the influence of various factors in driving fluctuations in an organisation’s performance and overall financial health.

It enables leaders to evaluate the possible financial impacts of different external forces — such as shifting market demand or increasing expenses — or internal forces — such as variations in staffing levels or organisational investments. Armed with these insights, leaders can better mitigate risks and prepare for change through more informed decision-making.

All of these benefits are achievable and laudable. Of particular value is the organisational learning that scenario planning brings to the table. Management teams typically have a strong appetite for understanding sensitivities to their business.

Many finance professionals know that educating executives on how changing assumptions impact the bottom line is perhaps more relevant than communicating the specifics of any individual forecast.

Finance leaders shouldn’t be called upon to be prognosticators or economists. Rather, they should be expected to understand the cause-and-effect relationships that drive the organisation and be able to convey those relationships to stakeholders in well-constructed and easy-to-understand models, plans, and forecasts.

The benefits of scenario planning include the ability to:


Hurdles to Scenario Planning

The most common issues with scenario planning centre on either modelling too many scenarios, or too few. With the former, organisations can spend inordinate amounts of time and resources running numerous scenarios that are not significantly different, thus offering limited insights for strategic decision-makers. With the latter, finance leaders risk missing opportunities to better understand the complexities of change and the interplay of various factors on the organisation’s future performance.

Other reasons why organisations have struggled to appropriately implement this functionality include:

Bandwidth constraints

We frequently hear that a lack of time is the biggest barrier to scenario modelling. Deficiencies in technology, data, and the underlying business logic can make processing scenarios laborious and time-consuming.

Well-designed solutions couple the right data with modelling logic to create a new scenario quickly. Sensitivity analysis — the process of altering a single driver assumption at a time — also takes very little time. More-involved, story-oriented scenarios with multiple variables can take longer to construct, but with the right tools, even these can be created in hours or days, not weeks or months.

Technology deficiencies

In some organisations, the underlying technology used to model scenarios can’t support the rapid creation and processing of multiple scenarios. Spreadsheets, for example, typically are not a good option.

Spreadsheet models fall short in managing and incorporating financial and operational data. They tend to be brittle and rely too heavily on macros developed by one model designer. Other purpose-built planning and forecasting solutions often fall short as well. While many support a “scenario” dimension to their data structure, they fail to deliver a robust business logic layer that is easy to set up and maintain.

Finance leaders risk missing opportunities to better understand the complexities of change and the interplay of various factors on the organisation’s future performance

Configuration deficiencies

Some organisations have the technological capacity, but the internal or external implementation team failed to configure the planning application to process scenarios. Unfortunately, this is a common issue; the organisation or the external consulting team helping to implement the system did not invest adequate time designing models with reliable cause-and-effect relationships built into the application’s business logic layer.

Even if cause-and-effect relationships are established, planning system designs must include dynamic assumptions and results storage. They also require sound business logic and plug-and-play assumptions to write versions of results quickly and efficiently.

Data deficiencies

A key to scenario planning is the inclusion of non-financial data sources. Internal and external drivers represent the independent variables that ultimately influence the dependent variables (financials). Many organisations continue to use general ledger history as the primary data source for planning. With these types of planning systems, users enter income and expense for their respective areas, and the tool aggregates the results. Such a construct inhibits scenario planning by making the creation of alternative scenarios an impractical, manual exercise. Finance leaders need systems that automatically apply operational drivers (both internal and external) to organisational processes to derive projected balance sheet, income expense, and other key metrics.

Lack of institutional knowledge

Lack of institutional knowledge hinders an organisation’s performance and contributes to data deficiencies that make it difficult to extract, transform, and load operating data. One can’t model what one doesn’t understand. Of all the hurdles to scenario planning, this may be the most difficult to overcome. Finance leaders must proactively engage with stakeholders from across the organisation to better understand what drives fluctuations in revenue, operating costs, and other financial indicators.

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As author Paul J.H. Schoemaker, former Professor at the University of Pennsylvania’s Wharton School, writes, “Scenario planning attempts to compensate for two common errors in decision-making — under prediction and overprediction of change. Most people and organisations are guilty of the first error.”

According to Schoemaker, certain conditions can be strong catalysts in motivating organisations to adopt a more rigorous scenario planning approach, as outlined below.

Catalysts for Adopting a Scenario Planning Approach

High uncertainty relative to management’s ability to predict or adjust

Too many costly surprises in the past

The industry has experienced significant change, or change is imminent

The company wants a common language and framework without stifling diversity

Strong differences of opinion exist, with multiple opinions having merit

Competitors have an advantage by using scenario planning

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In general, the scenario planning process involves identifying the key drivers of change for an organisation, calculating projections based on scenario modelling for potential variations in performance for one or more of those drivers, analysing the results, and then determining how best to apply those results to the organisation’s long-term financial and strategic plans.Scenario planning can be performed across an organisation or at the unit or initiative level. Common types of scenario analysis include:

Single Variable Sensitivity Analysis

Involves changing one variable at a time while holding others constant and quantifying the impact of that singular change. These types of scenarios are the easiest to process and provide a good starting point. They serve as an educational tool for management by helping to identify the drivers or model inputs that have the greatest effect on the organisation, and therefore deserve the greatest attention.

One criticism is that single-variable sensitivity analysis is too simple — market variables typically depend on multiple factors and seldom move by themselves. Even so, sensitivity analysis is valuable in that it clearly shows the impact of change in an underlying driver variable.

Different Types of Scenario Planning

Multi-Level Driver-Based Analysis

Is also known as “what-if analysis” and includes both independent and dependent drivers. It incorporates a series of independent drivers — such as volume and growth assumptions — that then cascade to affect downstream dependent drivers, such as departmental workload or supply needs. Multi-level driver-based analysis is a critical tool for effective contingency planning and offers insights into the “cause and effect” of multiple assumptions.

Initiative-Based Scenario Planning

Assesses the potential financial impacts of major business decisions, such as closing a specific department or business unit or launching a new service line. It involves incorporating different sets of initiatives together into a composite plan or strategy. Finance leaders can layer different initiatives or combinations of initiatives on top of a baseline to gauge their combined impacts.

Scenario planning can be performed across an organisation or at the unit or initiative level



Implementing Effective Scenario Planning

The first step to establishing a successful scenario planning model is to conduct workshops with stakeholders from across the organisation to identify key operational drivers and define the most relevant scenarios. These scenarios may be based on ranking key drivers in order of their impact or influence upon the organisation. The scenario team also can rank drivers by level of uncertainty. Drivers that are both influential (high impact) and relatively uncertain typically represent the best opportunities for scenario development. Be sure to include them in sensitivity analysis and more comprehensive multivariable, storyline scenarios.

As much as possible, planners should automate the sourcing of nonfinancial driver information, storing a minimum of 12 months of history — but preferably 24 months or more. Finance leaders can begin reporting these variables along with financial results. By regularly presenting internal or external market and operational data together with financials, stakeholders will begin to better correlate how the former impacts the latter.

Having historical data also allows finance leaders to create business logic and test that logic against past experience.

A summary of five key steps to developing an effective scenario plan are:

Establish driver assumptions

Well-constructed scenario planning models identify an organisation’s key business drivers. In a standard cause-and-effect relationship, these are the independent or causal variables.

Define the business logic

The interplay between driver variables and financial outcomes forms the heart of any scenario planning model. In this step, finance leaders must define algorithms that best emulate the dynamics of the organisation.

Collaborate with stakeholders to review inputs

Once finance leaders have identified key drivers and defined the business logic, they should work with stakeholders or subject matter experts to review those assumptions and make adjustments based on their feedback.

Execute the scenario analysis

Finance leaders use various tools to conduct scenario modelling, from simple spreadsheets that require manual calculations to more advanced scenario planning software solutions that allow for automated calculations.

Store and present scenarios

After the scenario mapping is complete, finance leaders should save their scenario analysis in an accessible format for future reference and recalibration. The core findings then should be translated into easy-to-understand presentations for stakeholders. Whether in reports or dashboards, side-by-side comparisons should include key drivers, financial information, and a narrative around the contents of the scenario.

Scenario Planning Workflow

Driver Assumptions

Baseline V1 V2 V3 V4

Business Logic Layer

Collaboration, Inputs and Overrides

Scenario Storage

Scenario Presentation


Scenario planning is a valuable strategic management tool that allows for sound, data-driven decision-making and more robust strategic planning. Through scenario planning, finance leaders gain insights into assumptions and biases that may otherwise be hidden, reveal opportunities and areas of risk, and expand the scope of their strategic options.

It allows them to take the status quo as the “base case” and explore the best, worst, and neutral impacts of various scenarios. Finance leaders can use scenario planning analysis to help reset strategic priorities, determine future budget targets, reforecast an annual budget, update a rolling forecast, or reshape a five-year strategic plan.

Given the uncertainty in today’s environment, organisations need the ability to run various scenarios and mitigate risk by quantifying potential performance volatilities. Yet finance leaders across numerous industries have not incorporated scenario planning into their strategic planning, budgeting, and forecasting processes. Many organisations simply lack optimal tools to conduct efficient and effective scenario modelling.

With the right scenario modelling software, finance leaders can significantly reduce the amount of time, effort, and resources needed to perform scenario modelling, and greatly increase the accuracy and range of their analysis. Strategic planning software that includes scenario modelling capabilities can rapidly create and process multiple scenarios.

Conclusion

Axiom’s planning solutions provide the strategic planning tools that enable organisations to model multiple scenarios and develop mid- and long-term financial plans that align with their strategic goals. The solution empowers finance leaders to:

• Efficiently create scenarios to mix and match assumptions — in minutes rather than days or weeks as required by some other solutions — such as current demand, projected growth, wage inflation, and interest rates

• See the impacts of proposed strategic initiatives and capital projects

• Generate a full set of forward-looking financial statements based on the desired planning horizon

• Deliver executive-level dashboards with operational, financial, and third-party data

While no organisation truly can predict the future, automated scenario planning tools can assist by simulating an array of possible outcomes. Such tools are increasingly essential. There are many potential futures, and organisational leaders should be prepared to steer their organisations forward along any number of possible paths to success.

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With Axiom you can respond to the financial challenges today, while developing opportunities and innovations to stay ahead of the competition tomorrow. Covering budgeting, cost management, planning, analysis, and reporting, Axiom’s solutions can help you adapt confidently to changing market conditions and operational priorities, aligning strategies with operational budgets and forecasts.

To plan for all eventualities and outcomes, decision-makers require accurate forecast and budget data, both financial and non-financial, along with in-depth ‘what if’ scenario planning. Axiom integrates structured and unstructured financial data for a joined-up and single view across your entire business, ensuring your processes are highly efficient and robust.

From financial planning to budgeting and beyond, our rich reporting and modelling functionality enables you to report, track, measure and plan for immediate reporting and long-range plans. With our Budgeting and Forecasting solutions you can leverage real-time data to acquire insights, accelerate informed decisions, and advance plans. With Axiom Reporting and Analysis, you can transform data into insights to power the financial performance of your business.

Axiom’s financial performance management software means you can model and test different financial plans and initiatives and have total control over every aspect of your finances from cash flow management to capital planning. We give you the tools to prioritise and determine the right opportunities and investments to support growth, now and in the future.

Axiom solutions – Fit for the future

Why not get in touch and see how Axiom can help your office of finance face the challenges of today and tomorrow.

Contact us by emailing [email protected] or call us on +44 1932 548 465 to talk to one of our specialists.

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