Your Guide To Financial Modeling And Scenario Planning
Strong leaders are always thinking about the future. Forward-thinking is an essential part of business leadership to guide your employees and steer your company in the right direction.
In uncertain times, it is important to understand many different outcomes that could take place. Trying to build a model based on multiple possible outcomes is challenging. You may find that you need help.
Finance and accounting leaders within an organization frequently need assistance predicting their cash needs, drawing a mental picture of potential profitability, and learning how to make better data-based decisions for the company.
To plan for the future effectively, a leader must develop a financial model whose aim is to forecast a business’s results over a set time frame.
Read More: Financial Tips From Successful Leaders
Given the current environment, we recommend creating a nine-month cash flow forecast to support your business through whatever comes your way.
We recommend keeping three possible business scenarios in mind:
- Your original plan
- A probable case based on current data
- The worst case
To help you, we suggest brushing up on those Excel skills to create more elaborate and complex financial models. These models will enable you to modify assumptions giving you the ability to see the outcomes immediately. If you are not an Excel guru, don’t worry, even a simple financial model will provide you with better insights into your business.Start the Conversation
3 Scenarios And What They Tell You
- The original plan scenario should be your current strategic business plan and budget for the year. If you do not have a budget, you can create this model, as outlined below. This scenario acts as the baseline for the other two scenarios.
- The probable case scenario is what you expect to happen based on current information. For some businesses, this could mean growth, and for others, it may mean a reduction in revenue.
- The worst-case scenario should depict what the business would look like if revenues drop, are delayed, and/or unforeseen expenses occur. This scenario reflects the most serious or severe outcome. In this scenario, forecasting in this way is critical, so preparations can be made to ensure the business can still operate under adverse circumstances.
Read More: How to Develop a Strategic Financial Plan for Your Business
Original Plan Scenario
The best approach to building these scenarios is to start with the original plan. Your original plan scenario should be the easiest to forecast, and you might already have it if you created a strategic business budget for the year ahead. The numbers used in the original business plan will act as the baseline for creating the other two scenarios.
A quick way to get started building the financial model is to calculate a monthly average of the last 12 months for each expense category. At Signature Analytics, we recommend companies break down their expenses into categories or buckets to understand their business expenses better.
Once you have that data, use this average as the baseline amount for each expense account. Then ask yourself, is this baseline still a reasonable estimate to help forecast for the next nine months?
Depending on your income channels, revenue can be forecasted using the 12-month average. If you have more accurate data, then, by all means, use it. For both revenues and expenses, look back at the same months in the previous year to see if any seasonal patterns or trends should be reflected in the forecast and make adjustments where necessary.
Lastly, if you never created a strategic business plan and budget for the year, there’s no time like the present to get that started, so you are not flying blind over the next several months.
Read more: Download our Strategic Budgeting eGuide
Probable Case Scenario
Once the Original Plan has been created, determine what percentages (these would be increases or decreases) of revenue and expenses should be applied.
Manual adjustments can be made to any of the monthly numbers based on knowing future activities within the business. Think through possible disruptions to your employees, your supply chain, and your clients.
Worst Case Scenario
The final scenario is weighing in the negative impact of disruptions to your employees, your supply chain, and your clients. You might approach this as a broad decrease in revenue (15%, 25%, or even higher) to understand how that would affect your business and your liquidity.
Scenario planning should bring to light any warning signs that can trigger major strategic pivots to decrease a company’s risk.
One other helpful tool in scenario planning is to utilize storytelling. The Wall Street Journal reports that “data-driven stories enable a team to picture the various futures the organization might face; strong narratives challenge conventional wisdom and management’s assumptions, but should be logical and plausible.”
Remember, forecasts by nature are not factual; but, having the ability to use available forecasts to develop scenarios can provide some relief.Talk to An Expert
Simple scenario analysis allows you, as the business leader, to work through the assumptions and influences that directly affect your business. This creative and focused thought process can support you in times of high stress when making thoughtful, yet data-driven decisions for your business beyond that “gut feeling.”
If you need help with creating different financial models to support various scenarios, Signature Analytics has a full staff of CFOs and accounting experts to support you and your business. When you are ready, contact us to get started.