Scenario Planning Explained: Definition, Process & Best Practices
After what seemed like a golden age for high-growth companies, the global pandemic in 2020 and market downturn in 2022 have ushered in a new era of business uncertainty. This is an opportunity for finance to be the compass that points business leaders in the right direction to get through these difficult times. And one of the best tools at your disposal to do just that is scenario planning. Learn how to make scenario planning an agile, continuous part of your planning processes.
There was a time not too long ago when finance teams could get away with simple scenario planning processes.
You could build basic models for base-case, best-case, and worst-case scenarios during strategic planning processes and present a conservative option for executive and board approval. And that was enough.
But times have changed.
In the wake of a global pandemic and a market downturn verging on a full-blown recession, detailed scenario planning is suddenly among your top priorities.
Now, maintaining base-case, best-case, and worst-case scenarios is table stakes. True strategic finance functions go a level deeper, running multiple what-if models on the fly and pulling levers in real time to show department heads and executives how new plans could impact runway and growth. This guide will help you understand how to do just that.
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What Is Scenario Planning?
Scenario planning is the process of mapping out how different strategic plans and external forces will impact a business, showing the potential outcomes of those circumstances to improve decision-making.
Traditionally, scenario planning has applied broadly to management and executive roles as leaders try to better plan for the future. But finance teams are best suited to take on scenario planning responsibilities — especially in the midst of uncertain future market conditions.
In the context of finance, scenario analysis is the process of building out new models to show how strategic decisions will impact financial efficiency and company growth. Those models include tweaks to various financial assumptions and operational drivers to help the business make more data-driven decisions about the company’s future.
4 Types of Scenario Planning (and Why You Shouldn’t Worry About Them)
Because the term “scenario planning” is so broad, you’ll see many guides talk about different types of scenario planning. These might span use cases from finance to more general business planning, military strategy, and geopolitical risk management.
The four most common types of scenario planning you’ll come across in business settings are:
- Quantitative scenario analysis. This is the classic financial planning use case where you build models for different cases of business and financial performance. If you’ve built multiple scenarios in your annual planning process, you’ve done quantitative scenario analysis.
- Normative scenario analysis. A goal-oriented form of scenario planning most popular in traditional corporate settings where you lay out where you’d like the company to be at the end of the given period. It’s a much more qualitative approach that focuses more on company vision than financials.
- Operational scenario analysis. A more granular form of scenario planning that explains the possible outcomes of individual decisions or events in the short term. This is the kind of analysis you do when you build scenarios alongside individual department leaders.
- Strategic management scenario analysis. This is the kind of scenario analysis that focuses more on external factors than internal ones. You may involve industry analysts to better understand how the market is receiving your product and how roadmap decisions would impact total addressable market (TAM).
While it’s good to know what each of these types of scenario planning is, worrying about which is the “right” one won’t do you much good.
The reality is that strategic finance teams should be running scenario analyses that look more like a blend of each type. You need to understand the company’s numbers inside and out at the macro and micro levels. And you need to master financial storytelling to explain the “why” behind those numbers.
So, don’t worry about choosing which type of scenario planning to use — focus more on having a great process for understanding scenarios and their possible future financial and operational outcomes.
Why Is Scenario Planning Important?
Scenario planning elevates finance’s role as a strategic partner to executives and department leaders because it helps the business make more data-driven decisions. When you make scenario planning a continuous initiative, you’re helping the business see around corners and choose the right path to hit its goals — no matter what changes internally or externally.
On a high level, helping leaders see around corners makes it easier for you to maintain optionality as a business. But what does that really mean in practice? There are a few benefits you get from agile scenario planning that will help drive business success.
It aligns the business on its key drivers
One of the biggest challenges you face as a finance leader is being able to translate numbers and models into a language the business can understand. Building a perfect financial model won’t do you much good if no one in the business can understand it. And with so many different financial assumptions and inputs cobbled together to create a holistic view of the business, it’s unlikely anyone but you will understand the spreadsheet.
Scenario planning forces you to identify the key drivers of business performance. Instead of changing every input in the model, you pull a few different levers and see how they impact performance. Making small changes to key drivers will help the business understand the true financial and operational impact of its decisions.
This is important at both the company-wide level and the department level, giving you the tools to communicate effectively about what your stakeholders truly care about.
It helps avoid surprises for investors
The true value of investor updates and board meetings is the ability to tap into their experience and perspective to solve business problems. But you can’t unlock that value if investors are caught off guard by unexpected numbers every time you connect.
Strong scenario planning practices help avoid surprises for investors by proactively showing the potential outcomes of decisions. Instead of spending the majority of your time talking through what the numbers are, you can focus more on how to work through various scenarios in the months ahead.
It shows you different ways you can extend runway and better manage cash
The ecosystem of VC-backed startups went through a golden era where growth at all costs was the norm. Funding was far too available for it not to be. But as market conditions change, sustainable growth becomes a necessity. And that means finding ways to extend cash runway and optimize cash flow.
Your CEO needs to stay on top of two things at all times — how much cash is on the balance sheet (and how long it will last), and how to stretch the company’s cash as far as possible. Scenario planning helps you be a strategic partner in that effort. As executives look for areas to conserve cash, scenario planning allows you to show the impact of different decisions and help decide on the best path forward to safeguard the company against future events.
The 5 Steps of the Scenario Planning Process
You know your business could benefit from more agile scenario planning. And you know that there’s significant value in going beyond simple company-wide scenarios for base case, best case, and worst case. The next step is to build out a scenario planning methodology that works for you, your partners across the business, and the company at large.
Follow this walkthrough to better understand what goes into a best-in-class scenario planning process.
1. Collaborate with Business Leaders on which Levers to Pull
Always start a scenario planning exercise by collaborating with your business partners. You need to work together to figure out what exactly you want to dial up or dial down in the plan.
Technically, you could change any operational variable to come up with a new scenario for the business. But it would be complete chaos if you started toggling any and every lever at your disposal. Instead, focus on a couple of things:
- What can you control? You want to build models based on levers that you actually control. The scenario itself might be out of your control (i.e., what if we hit a market downturn and appetite for new software diminishes?). But things like your hiring plan are always in your control. Create a game plan around the big, controllable levers at your disposal rather than unknowns.
- How do levers match up with proposed scenarios? You can start with the end in mind with scenario planning. If you want to create a case where you miss top-line growth goals significantly, what are the relevant levers that could make that happen? Maybe conversion rates drop, or you have attrition on the sales team, or there are product delays.
The outcomes of these conversations will help you go back to your model and start analyzing different scenarios.
2. Start with the Baseline Financial Model
The conversations you have with business partners should always be the basis for how you build your model. You want to make sure that your model goes beyond the accounting basics and breaks out the components of the business from an operational perspective.
In reality, this is more like a prerequisite for agile scenario planning than an initial step. If you try to run scenario planning processes with a high-level model that doesn’t include operational components, you’ll likely finish the exercise with simple outputs that don’t necessarily guide strategic thinking.
In that case, you’d have to go back and rebuild your model anyway to satisfy company needs. Instead, blend the financial and operational aspects of the business in one model and create the right foundation for scenario analysis.
For more info about building a flexible operating model for your business, check out this episode of The Role Forward with Jenny Jao, Head of Finance at Sprig.
3. Pull Levers in the Financial Model Based on Business Needs
The goal of your initial conversations with business leaders is to get a deep understanding of what’s important to them. That’s how you create scenario analyses that have strategic impact.
In theory, if you wanted to create a down case, you could go into your model and just cut every assumption by 20%. You’d get the right outcome, but you didn’t account for anything your partners truly care about.
This comes down to recognizing the non-negotiables for your model. For example, how does your business want to handle a down case where you hit $3.5 million ARR instead of $7 million ARR?
- Do you want to keep cash at a certain level given that outcome?
- Are you going to have to double down on retention instead of new customer growth?
- Will you still need to hire certain mission-critical heads despite a new focus on lean growth?
These types of questions will impact how you pull levers to build your scenario plan. Strong scenario planning processes always revolve around what’s important to the business, guiding you on which levers to pull to reach the intended outcomes.
4. Present Multiple Scenarios and Toggle Inputs Live
There are two primary ways you can present your scenarios to the business. The first is in the context of annual planning processes. In these cases, executives may communicate the handful of main scenarios they want you to build out, so you present different models for each set of guidelines.
The other way you can present scenarios is the more agile approach. If you build a flexible operating model, you should be able to sit down with your executive partners and live toggle different levers in a scenario. You might come to the conversation with your three basic scenarios, but you can then show executives what would happen in each scenario if you tweaked the inputs and assumptions.
Headcount scenarios are the classic example. You can build high, base, and low cases for headcount to start the conversation. But headcount is such a massive lever for your business that it wouldn’t make sense not to treat it dynamically. You can toggle inputs in each case to see how changes to strategic plans — regardless of scenario — will impact performance.
Note that one of the hardest parts of scenario planning in spreadsheets is version control. The more scenarios you build out, the harder it is to keep track of what levers you held constant and which ones you changed. Being able to lock a base case model, clone it, and mix and match different model components with a few clicks is one of the biggest benefits of adopting financial planning and analysis software.
5. Continuously Collaborate on Company-Wide and Department-Level Scenarios
Internal and external circumstances change far too quickly and often to assume the scenarios you map out at the beginning of the year will hold strong three, six, or twelve months down the line. A good scenario planning process has to account for the fact that you need to revisit and rethink your analyses continuously throughout the year to adjust tactical courses of action.
You need to revisit scenarios at both the company-wide and the department levels. At the company-wide level, you should at least be revisiting your scenarios on a quarterly basis when it comes time for board meetings. Being able to run a budget variance analysis between your actuals and each scenario will set the stage for more valuable conversations between you and your investors.
But on the department level, you should treat continuous scenario planning as a way to collaborate more closely with business partners on operational plans.
For example, what’s the trickle-down effect of missing revenue goals on the hiring plan in customer success? The main financial model for the business may just show a reduction in headcount for CS — but does that really make sense? Discuss various scenarios with your CS leader to understand the qualitative impact of various scenarios on their strategic plans and see if there are different levers to pull that make more sense.
The more you understand the dynamics of each department, the more effective your scenario planning processes will be. Going through this process monthly or quarterly will deepen your understanding of the business and elevate your role as a strategic partner.
3 Tips for More Effective Scenario Planning
There’s no one-size-fits-all way to succeed with scenario planning. So much effective scenario planning comes down to understanding the dynamics and needs of your specific business.
But just because every scenario planning process is unique doesn’t mean there aren’t universal elements and similarities. The steps listed above cover the end-to-end process, and these three will help you take a step even further toward best-in-class scenario planning.
Run multiple scenarios even when you aren’t asked to do so
Traditionally, scenario planning has been such a time-consuming process that you’d only go through it if necessary. In many cases, that meant when executives asked for multiple scenarios during the annual planning cycle.
Strategic finance teams take it upon themselves to run alternate scenarios even when the business isn’t specifically asking for them. Be curious about how different levers will impact the business. See what might break the model altogether. This kind of curiosity is what helps you uncover strategic insights that make finance a driving force for business growth.
Prioritize business partnering over modeling
It doesn’t matter how beautiful or perfect your financial model is if no one in the business actually uses it. That doesn’t mean your partners should be jumping into the model and making changes themselves necessarily. But rather, it means you have to build the model according to the needs of your business partners.
Don’t start scenario planning by diving straight into your models. Always start by having conversations with business partners and gaining a deep understanding of what they need and how their corners of the business operate. That way, when you’re building the model, you’re actually creating an architecture that makes creating new scenarios a seamless process instead of having to rebuild models for every new request.
Automate the time-consuming side of scenario planning
The only way you can make scenario planning an agile process is to get out from under the heavily-manual process of data aggregation and cleansing. Because you’re working with so much data, the process of pulling actuals from different source systems, organizing it, and tweaking it across multiple models for possible scenarios becomes more time-consuming than it’s worth. By the time you actually finish building all your models, the data is probably already stale.
Keeping up with the pace of modern businesses requires real-time data. Automate the data aggregation and cleansing side of the job so you can focus more on identifying those big levers that will make a difference in strategic action plans.
Scenario Planning and Forecasting with Mosaic
There are two main roadblocks that will prevent you from effective scenario planning — manual data aggregation and inefficient version control in spreadsheets. Mosaic eliminates these challenges by integrating with your most critical source systems and providing a platform to easily duplicate models, tweak assumptions and inputs, and describe scenarios easily.
Traditional scenario planning and modeling could take weeks of work to complete. And even then, you might only come away with a few basic scenarios only to get a list of new requests once you present them. In Mosaic, you can create new scenarios in less than two minutes. Watch how.
Don’t let manual processes and spreadsheet limitations keep you from being the strategic partner your company’s leaders need. Reach out for a personalized demo to learn more about how Mosaic can transform your scenario planning processes.
Scenario Planning FAQs
What is scenario planning in finance?
In finance, scenario planning is the process of collaborating with business leaders and building out models that show how changes in different variables impact future outcomes for the company. It’s an analysis exercise that finance can use to help the rest of the business understand potential future outcomes of strategic plans.