Financial Scenario Planning for Economic Uncertainty

In an uncertain economy, detailed financial scenario planning is more important than ever, regardless of the size of your organization.

Economic uncertainty can be challenging for businesses of all sizes, but it is possible to survive and even thrive during volatile times. Because the economy is a complex system that is influenced by many factors, including government policies, global events, consumer behavior and technological advancements, it can be highly unpredictable. As a result, businesses can find it difficult to forecast spending, saving and investments. However, there are proactive measures you can take to protect your business, ensure resiliency and even position your company for growth, despite economic volatility.

In this post, we’ll explore how financial scenario planning can help you anticipate potential situations, identify risks and opportunities, and develop contingency plans to emerge stronger. We’ll also look at how cash flow impacts scenario planning, and cash flow solutions to consider.

What is scenario planning and why is it so important for SMBs?

Scenario planning is a critical tool that enables businesses to prepare for a range of possible futures. In times of economic uncertainty, scenario planning can help businesses recognize warning signs, adapt to various outcomes and mitigate risk by preparing for both worst-case and best-case scenarios. The scenario planning process involves developing several plausible future situations and exploring the possible outcomes of each one. It allows for a more flexible approach to financial planning, making it easier to adjust plans as circumstances change. 

Scenario planning is important for small and mid-sized businesses (SMBs) because it helps them contemplate and stress test a variety of strategies. From projecting earnings and forecasting cash flow to developing mitigation tactics, scenario planning is more than just a financial planning process — it’s an all-encompassing strategy to handle economic uncertainty.

Best practices in scenario planning

When you perform financial scenario planning, it is essential to develop a comprehensive strategy to reduce risks, capitalize on opportunities and establish resiliency. Here are some best practices and considerations for effective scenario planning:

Identify the key factors that could impact your financial situation

When the future is unclear, the questions you ask on the front end of scenario planning are especially important. Those questions should be high-level and open-ended. For instance: 

• What’s happening to our company, and the world at large, on a macro- and microeconomic level?

• What uncertainties will have the greatest impact on us?

• What impact will disruption to our supply chain, or the scarcity of materials, have on our business and customer satisfaction?

• What are the most likely situations our company will face in the near future?

• How will each situation affect the company, and what are key metrics and KPIs to effectively measure our performance during that scenario?

These questions provide the groundwork for anticipating and measuring your company’s future growth and performance.

Pinpoint and prioritize key financial risks

To scenario plan effectively, you should identify financial risks and prioritize them by importance. Risks can include changes in interest rates, exchange rates, commodity prices, inflation, credit risks and more. Classifying the risks will help you decide how to allocate resources and build targeted strategies to address them. 

Develop realistic scenarios

It’s critical to develop realistic financial scenarios that reflect a broad range of potential outcomes. The scenarios you choose should be informed by current market trends, historical data and expert insights. Avoid overly positive or negative scenarios that may not accurately reflect the reality of market conditions.

Evaluate impacts and responses

Once the scenarios are developed, it is crucial to evaluate their potential impacts on your business’s finances — revenues, costs, profits, cash flow and capital structure. Furthermore, your evaluation should be accompanied by a range of potential responses, including cost-cutting, capital raising and risk mitigation strategies.

Build in flexibility

Flexibility is essential in financial scenario planning. You should develop scenarios that are adaptable and allow for quick responses to changing market conditions. This flexibility can be achieved through contingency planning and developing multiple response options for each situation.

Monitor and update

Financial scenario planning is an ongoing process that requires regular monitoring and updates. It is important to review your scenario plan regularly, track changes and revise your strategies when necessary.

Scenario types to plan for

Until recently, mapping out two likely scenarios for the executive team was effective and acceptable. However, in today’s uncertain economic landscape, it’s now worth creating five or more scenario plans. At the very least, you should plan and set priorities for three possible outcomes:

• The worst-case scenario (for example, customers have stopped buying your product or service, and business is drying up).

• The OK-but-not-so-great scenario (for example, demand for products or services remains strong, but customers are taking longer to pay).

• The best possible scenario (for example, orders are coming in, and the company’s cash position remains stable).

This approach helps your management team establish parameters for company performance — from a four-alarm emergency to sustainability or even growth. Considering a range of potential outcomes can lead to better decision-making and fewer surprises.

How cash flow impacts scenario planning

During times of uncertainty, strong cash flow management and forecasting are essential. To develop a solid scenario plan, you need to understand the dynamics of your company’s cash flow to determine your response strategy. A cash flow forecast can enable you to prepare for emergency expenses or other unexpected costs, helping you decide whether to revise your accounts payable processes, inventory levels or invoice management strategy to free up cash.

Here are some tips to help you improve your business’s cash flow management practices:

Take a comprehensive look at cash inflows and outflows

Start by looking at the cash your company has coming in. What are your main sources of cash flow, by customer and industry? How will those categories be affected by a dip in the economy, social unrest or changing government policies? What will this mean for the volume of your business? Economic shifts affect different businesses in different ways. When forecasting future cash inflow, examine how each of your key customers will be impacted by different situations.

Your next step is to break down cash outflows into categories that help your leadership assess risk and make decisions. What are your variable and fixed costs? Are there any discretionary costs (for example, investments in new technology or business travel expenses) that could be delayed or eliminated in the event of an adverse situation? 

In an unpredictable environment, breaking down cash inflows and outflows, and applying them to each possible scenario, can help you anticipate shortfalls and understand how to course-correct.

Engage key stakeholders

While the questions you ask during scenario planning tend to be high-level, the data you collect to answer them should be granular. That means engaging key stakeholders across every part of the business to get their input. Developing financial plans can no longer take place in a bubble. Collaborating with and collecting information from sales, marketing, operations and other teams will add depth and perspective to scenario mapping.

This is an area where the CFO should be seen as a key strategic advisor for the organization. If your company culture is one of transparency and collaboration across different functions, you’ll find it easier to engage everyone in the scenario-planning process.

Use tools that can be updated in real time

Since it’s likely that your CEO wants to see your latest scenario planning report “yesterday,” it makes sense to compile your data on a secure, cloud-based, shareable platform that you can update in real time. Static spreadsheets saved on your local desktop can quickly become outdated, especially if many people are working on the report concurrently.

There are a number of ways to facilitate this flexibility. Here are some of the more popular tools available today for scenario planning:

• Excel’s Scenario Manager enables you to enter as many as 32 components of your cash flow forecast.

• The Monte Carlo Simulation Technique, also available in Excel, can convert a static spreadsheet into a Monte Carlo simulation, a mathematical model for creating random variables measuring risk and uncertainty.

• Praxie’s online scenario planning collaboration tools allow your team members to use templates and forms.

• Creately also offers several free scenario planning templates for you to download.

Consider cash flow solutions

In uncertain times, you’ll want to consider how you can maintain a healthy cash flow in any given scenario. Do you have a solid backup plan for improving cash flow and accessing working capital when you need it? Some possible solutions for alleviating a cash crunch include:

• Identifying expenditures that can be delayed or eliminated.

• Revising invoice strategies, such as renegotiating invoice payment terms with your buyers.

• Tightening inventory management to reduce the costs of holding too much product.

• Asking your lender to defer loan principal or interest payments until conditions improve.

• Researching alternative financing solutions that can help you optimize cash flow. For example, early payment programs like C2FO’s can give you more control over working capital.

• Exploring government funding options such as those available from the US Small Business Administration (SBA).

• Leveraging supplier diversity programs if you qualify as a minority- or women-owned business.

In summary

Scenario planning is a valuable tool your business can use to prepare for potential financial challenges and uncertainties. Today’s ever-changing economy has heightened expectations for finance professionals to provide planning and analysis more frequently and for an increasing number of potential scenarios. That also means developing scenario plans that ask the big questions about the future, while also collaborating with key stakeholders to ensure the plan has as much detailed information as possible.

Fortunately, many software tools are available to help you conduct scenario analysis in real time and with greater accuracy and frequency to satisfy your executive team. Ultimately, leveraging best practices and cash flow improvement tips will help you create robust scenario plans that mitigate risks and ensure your company’s long-term sustainability.

Learn how early payment programs can put you in control of your cash flow.

This article originally published November 2020, and was updated March 2023.