Navigating uncertainty: The power of scenario planning in financial decision making

What if? That’s the question that you’ll ask yourself over and over (and over) when engaging in scenario planning, a well-worn tool that business leaders use to make agile, forward-thinking decisions about future challenges.

What is scenario planning?

In finance, scenario planning is largely what it sounds like: Leaders analyze potential uncertainties and opportunities in future conditions in order to strengthen the accuracy of financial forecasts.

“As the Covid-19 pandemic has shown, many situations lack historical data for teams to refer to when creating plans, making swift decisions and accurate forecasting difficult,” an Oracle report noted. Scenario planning can help finance leaders “minimize risk, stay agile, and maintain business continuity,” the report noted.

Where did scenario planning come from?

It’s essentially a more formalized version of what businesses have always done in some form. The method has been around for a while: In a 1995 essay, decision science expert Paul J.H. Schoemaker called scenario planning “a disciplined method for imagining possible futures”—and that’s the crux of it. But given the uncertainty of the past few years, it’s become increasingly important to have a formalized process in place, and more and more leaders are taking note.

“Three-quarters of corporate strategy leaders say significant pivots to strategic plans now happen more frequently,” Marc Kelly, vice president of research at Gartner, said in a brief about strategic planning. Leaders who “understand how disruption affects enterprise strategic and operational decisions can make small but powerful changes” to ready their teams for both “the risk and opportunities that come from volatility,” he noted.

The power of scenario planning

Scenario planning is most efficient when addressing relatively probable possibilities: inflation, new competitors, and the like, which is why it’s an especially apt tool for financial decision making. Before any finance team starts implementing scenario planning in a more formalized capacity, there are some best practices to keep in mind, as outlined in the Oracle report.

Best practices for scenario planning

For starters, focus on key drivers that capture the current moment. “One way to start is by looking at your financial statements and asking, ‘What supports this line item?’” the report’s authors explained. “Don’t rely too heavily on traditional drivers that are more applicable to long-range planning.”

Just as crucially, you’ll want to analyze multiple sources of data, and apply a full trial balance. “Think across your full income statement, balance sheet, and cash flow,” the authors note. “Overly focusing on just two or three key areas, such as cash or revenue in isolation, will not give you enough transparency into cause-and-effect relationships.”

But also remember that there’s only so much you can predict. The Oracle report recommends limiting the amount of scenarios you model to a maximum of four. “Start with a broad set of scenarios, then narrow your set before running comprehensive analysis,” the authors explain. “As you go, build enough detail into each selected scenario to thoroughly assess the success or failure of your proposed solutions.”

And even with the limited set of scenarios you fully model, you’ll want to develop a plan for regular monitoring and tweaks to continually check their relevance. As the Oracle report notes: “Unfortunately, scenario planning isn’t ‘set it and forget it.’”