The value of scenario planning for your business
September 13, 2010
“What If?” is a question that we get asked a great deal. The forecasting process enables you to look ahead and consider the impact of various business decisions before making any commitment, such as:
What would be the effect on my business if I…
• Recruited more people?
• Opened another branch?
• Expanded into new markets?
• Increased my marketing spend?
• Undertook a programme of capital expenditure?
Scenario planning allows you to prepare for situations where you have no control over the variables. For example what would happen if…
• A competitor cut their prices by four per cent?
• A supplier increased their costs by six per cent?
• Exchange rates changed?
• Customers or suppliers change their payment terms?
You can set the target that you would like your business to achieve, for instance sales value, debtor days, stock turnover and gross profit percentage. You can explore the various resource scenarios you will need to have in place to attain these targets and demonstrate the financial effect.
The financing requirement of the business can be ascertained or the effects of potential changes in financing can be modelled, such as variations to an overdraft facility, taking on new loans, invoice financing and trade finance.
It is important that an integrated profit and loss account, balance sheet and cash flow are prepared when forecasting so that the whole financial picture can be considered.
The two case studies associated with this article show how powerful business financial forecasting can be for external funding purposes and as an ongoing internal management tool – answering those “What If?” scenarios.
Case Study 1
A business was expanding rapidly into a new market and part of the expansion required an increase in stock shipments from overseas. The timing of the increase in shipments and the funding gap needed to be ascertained.
As part of this planned growth, extra staff and associated increased costs needed to be budgeted for.
Additionally, the owner managers wanted to monitor actual figures against the budget to demonstrate a sound financial track record and calculate a monthly break even sales figure.
We worked with the management to prepare two year integrated forecasts. These demonstrated when the increase in stock would need to be ordered, shipped and paid for.
The owner managers were able to discuss the trade financing need with funders in good time with polished, accurate and detailed forecasts.
The actual financial figures are imported to the budget each month to enable variance analysis. A forecasted monthly break even sales figure has been calculated and assists in implementing the timing of the increased overheads.
Case Study 2
A business needed increased finance to support the working capital requirement.
Additionally, the management wanted to set targets for debtor days, stock levels and gross profit percentage.
The business has several branches and the management wanted to set budgets for each branch.
Working with the management, we prepared integrated forecasts, this time for a three year period. These highlighted the effects on the cash flow of the debtor days and stockholding targets as well as the increase in profits resulting from gross profit percentage improvement.
The demonstration of the financial effects of these targets was an effective management tool.
The financing need was ascertained and invoice financing offered by the funder. The financial viability of this was tested in the forecasts.