Scenario planning and forecasting in everyday business
Anyone running a business knows that things often turn out differently than planned. Initially focusing in one direction, internal and external factors, which were unexpected, can force companies to reconsider or even change their strategy, and often it’s not possible to react flexibly enough to favourable events. Therefore, it’s crucial for entrepreneurs to play out various scenarios and prepare potential strategies. Setting up scenarios can serve as a decision-making aid for strategic alternatives as well as assist in the development of specific strategies in case of unexpected internal and external events. Scenarios are particularly used in financial and liquidity planning to better estimate changes in cash flow and avoid liquidity shortages.
The leadership of a company is always faced with uncertainties. Often, things develop differently than originally planned. Both internal and external factors can force a company to rethink its strategy or make fundamental changes. A flexible reaction to these events is just as important as having the right management tools to handle unexpected challenges. That's why it is crucial to have alternative strategies prepared and why software that supports cash flow management can be helpful.
What is a scenario?
A scenario, in the context of business planning and strategy, is a detailed and structured description of a possible future situation, based on different assumptions. It is designed to anticipate various developments and prepare for them. Scenarios are used to identify risks and opportunities and to develop action strategies.
What is scenario planning?
Scenario planning is a strategic tool that enables the simulation of different future scenarios and the preparation of appropriate measures to handle them. This approach not only serves as a decision-making aid for strategic alternatives but also supports the development of specific strategies for dealing with unforeseen internal and external events.
Particularly in finance and liquidity planning, scenario planning plays a crucial role, allowing better predictions of cash flow changes and facilitating the creation of forecasts. It also enhances collaboration with stakeholders across various business areas.
Scenario Planning vs. Forecasting – The Differences
Besides scenario planning, forecasting is another essential tool for business planning and management.
Forecasts focus on a regular planning horizon and can rapidly adjust to new information thanks to their detailed nature, generally representing the normal case for business development.
Scenarios, however, are not mere forecasts or projections. They are developed considering possible realities, and do not solely rely on future predictions. Scenario planning allows businesses to develop scenarios based on the assessment of risks and uncertainties inherent in these predictions.
The planning horizons for scenarios and forecasts can vary. Whether a short-term or long-term planning horizon is chosen depends on the specific presentation.
Creating Scenarios: Normal-, Best- and Worst-Case Scenarios
The fundamental scenarios that consider the overall development of a company include:
- Normal-Case Scenario
- Best-Case Scenario
- Worst-Case Scenario
These scenarios assume different future states of the company and potential developments in the industry and overall economy. They take into account factors such as production costs, operational costs, interest rates, and inflation, which can affect the company.
Normal-Case Scenario
This scenario considers the average development based on previously defined assumptions and is the most realistic of the three scenarios. It is based on experiences and historical data and portrays a development that is not significantly influenced by any major positive or negative events.
Example: In a media agency, it is assumed that most clients pay on time, projects stay within budget, rent and wage costs increase moderately, and sales activities are satisfactory. The impacts would be stable revenues, controlled expenditures, ongoing projects, and a moderate improvement in market position.
Best-Case Scenario
Here, the ideal scenario is defined as the sum of positive influencing factors. This scenario is more optimistic but less likely than the normal-case scenario.
Example: In the media agency, the best-case scenario would mean that all clients always pay their bills on time, all projects are delivered as planned, rent, budget and wage costs are low, and sales activities are optimal.
Worst-Case Scenario
Worst-case scenarios consider the sum of negative influencing factors as the most severe negative variation of the defined assumptions. These scenarios are pessimistic but less likely than the normal-case scenario.
Example: In the media agency, the worst case would be that payments from clients are only received after several reminders, projects are not completed, and rent and wage costs rise while sales efforts are fruitless.
Scenario Planning: 3 Examples for Cash Flow Scenarios
Alongside general business scenarios, it is entirely feasible to test individual decisions and their impact on cash flow through scenario planning. Scenario planning and cash flow management are closely linked. By running through various future scenarios, businesses can create forecasts and explore different potential future scenarios, such as a worst-case or best-case scenario. These scenarios help to understand the possible impacts on cash flow.
Depending on the business model and the company, there are various cash flow scenarios. Below, we illustrate three examples for cash flow scenarios, looking at possible impacts and strategies.
1. Handling Late Payments
The timing of payments is a crucial factor for liquidity management. With efficient liquidity planning, every payment is anticipated in advance. If this date is not met, the liquidity calculation is no longer correct. In the worst case, all expected payments are delayed, which is common in project-based businesses with invoicing targets.
To assess this scenario, it is vital to know how much money the company has available in its accounts and what expenditures need to be made.
Possible impacts could include:
- Liquidity shortages
- Invoices and ongoing costs may not be settled punctually
- Financial uncertainty increases
Strategies to consider for this scenario might include:
- Short-term investments to bridge temporary gaps
- Introducing early payment terms as standard invoicing conditions
- Keeping credits or credit lines as a reserve
Considering this scenario helps with the risk assessment, ensuring the company does not run out of money.
2. Planning for Team Growth
The right team is one of the most critical factors for a company's success. Even with increasing revenue, the cost factor for new personnel should not be underestimated, as it is one of the most expensive in any company.
Possible impacts could include:
- Higher personnel costs affect cash flow
- Delays in new hires can slow growth
- Timely hiring enables better order processing and customer satisfaction
From this, the following strategies emerge to ensure cash flow security:
- Define revenue-related milestones that must be met before new hires are made
- Budget for personnel costs to rise promptly and monitor it flexibly
- Tailor-fit the budget for workforce growth to the company's needs and financial situation
3. Major Investments
Large purchases, such as new industrial machinery or laptops for the entire team, cost a significant amount of money. Sometimes it is worth questioning whether these purchases are truly necessary. The timing of these investments should be carefully considered to optimise the cash flow scenarios.
Possible impacts include:
- Significant one-time expenses impacting cash flow
- Modern equipment can enhance efficiency and productivity
- Long-term cost savings and potential increases in revenue are possible
Strategies to help assess the risk of this scenario include:
- Carefully plan and prioritise investments
- Explore financing options such as leasing or staged payments
- Calculate the Return on Investment (ROI) and ensure that investments are profitable in the long run
4 Steps of Scenario Planning with Tidely
Scenario planning is crucial for effective cash flow management. Tidely assists you in developing important, company-specific scenarios and supports you in all aspects of scenario planning:
1. Situational Analysis: Identify Key Factors
Initially, it is essential to identify the key factors influencing the business. Tidely provides a comprehensive overview of all financial data. The dashboard displays costs, revenues, expenses, and upcoming payments, allowing for quick identification and assessment of financial influences crucial for planning and setting realistic budgets.
2. Projections: Estimate Developments
After identifying relevant influences, the next step is to estimate potential developments. Tidely creates forecasts based on transaction data and upcoming payments. These projections help visualise various future scenarios, evaluating their financial impacts and enabling decisions to be made swiftly and accurately to steer the company's development precisely.
3. Create Scenarios: Calculate Combinations
For scenario development, it's necessary to set against various influencing factors and calculate their possible combinations. With Tidely, you can combine these scenarios with expected technological and regulatory changes, and directly analyse the resulting financial scenarios on the dashboard.
4. Impacts: Plan Goals and Strategies
In the final step, the most plausible scenarios are used to identify opportunities and develop strategies. Detailed financial reports can be found on Tidely. The software assists with decision-making and in planning new strategies, ensuring your budgets and plans are optimally adjusted under changing conditions.
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