FP&A teams everywhere are pondering the news and calculating their moves. Should they ramp up their research and design to churn out more product? Lower prices? Increase marketing? Do nothing?
FP&A’s response to a world of changing information and uncertainty is to maintain multiple points of view. We need to incorporate intelligence quickly (rapid reforecasting), remain focused on long-term strategy, and stretch the organizational mindset for the possibility of varied future outcomes, aka scenario planning.
Scenario planning is the ideation and analysis of possible future outcomes, including simulating the impact of complex changes on the business and robust evaluations of alternative courses of action. Inflexible budgets break; scenario planning is a structured approach to creating flexibility in planning and operations.
“Traditional EPM models give a view of the future, but typically are based on desired outputs or targets,” said Catherine Jirak, principal and COO, QueBIT. “Scenario planning shifts the emphasis to the inputs, the dependent and independent variables out of your direct control.”
Capturing these potential futures in stories engages our imagination, gives life to the numbers, and provides a structured approach for planning partners to visualize challenges and responses.
“Most plans represent just a single scenario; they ignore the presence of uncertainty. We know the future will be different than we anticipate, we don’t have a crystal ball,” said Jack Alexander, CFO-turned-advisor and author. Specifically, Alexander notes that scenario planning can help to overcome the following limitations inherent in single point planning:
- Dispel the illusion of control: “Single plans provide a false sense of security in that we think we have more control over the outcome than we do,” Alexander said.
- Stretch team thinking: If you only have one scenario, it is hard to challenge that projection and point to other outcomes. This leads to groupthink or pandering to the leader.
- Overcome common biases: We are all subject to various biases and social dynamics: optimism, overconfidence, confirmation, recency. Scenario planning asks us to imagine different outcomes.
- Encourage critical thinking: Models and plans contain explicit and implicit assumptions; alternative scenarios uncover and challenge those assumptions.
- Create a proactive mindset: The creation of alternative scenarios forces the examination, preparation, resilient planning, and cherished advisor role that FP&A seeks to become.
- Encourage cross-functional teamwork: Ideally, the process can help business leaders see the interdependence of their company, the need to support other departments and reallocate capital, minimizing budget fiefdoms. A well-orchestrated process can encourage multiple groups to plan together.
Scenario planning is a complementary process to budgeting and forecasting, based on the recognition that multiple outcomes are possible. Scenarios prepare us to think differently than where our own assumptions would lead us — a practice all FP&A professionals need to embrace, particularly as we navigate these uncertain times.
For more information on this topic, download AFP's Guide to Scenario Planning and attend FinNext Virtual 2021 for sessions like: " The New Normal: Scenario Planning as a core part of your Financial Management Process"