Financial scenario planning and the budget process

In a fast-changing business environment, companies and organizations need to be able to quickly monitor their financial situation and make changes in their plans going forward. Financial scenario planning (financial modelling) is an important part of the work – and is something that is used to estimate possible changes in the value of a company or in the cash flow, especially when there are favorable and unfavorable events that could potentially impact the company.

Scenario planning in itself is an analytical tool and process with which to examine and evaluate possible events or scenarios that could take place in the future, and predict the different possible outcomes. This can be done at a strategic level or purely financially. Not least, the budget and forecasting work is affected.

In normal times, the budget process is a consensus process that is based on a common view of the future which guides a company’s investments and revenues during the coming period. The risk, however, is that the budget process is not agile enough if and when the all-important preconditions change.

ALTERNATIVE FINANCIAL SCENARIOS

Working with rolling forecasts (such as, a rolling 12-month forecast) and/or working with alternative financial scenarios, can make it easier for you to act quickly when faced with unforeseen events.

According to Hypergene’s partners PWC, the right forecasting tool “must be sufficiently flexible to be able to deal with recession scenarios. The modelling must be able to demonstrate the effects of fixed, variable and fluctuating costs as well as problems with sales and production."

PWC emphasises that “you must have accurate and up-to-date factors in your model in order to be able to accurately estimate and communicate the expected effects on your business. Communication is an important part of the process since it gives everyone involved in the forecasting work the same starting point and the same frame of reference. A clear dashboard can enable and facilitate communication.”

EARMARK RISK LEVELS IN FINANCIAL SCENARIOS

According to McKinsey, CFO’s and financial managers can and should earmark risk levels in order to know if and when to implement a contingency plan designed for that particular scenario. They can also follow the development of events in the same way and inform the management continuously, even after a new plan has been activated.

The new plan does not have to affect the whole company. It can be used in a subsidiary or by a department. The affected part of the business may then need to develop and apply new budgets and review their risk strategies, capital allocations and financing.

McKinsey also believes that one way to evaluate financial scenarios is quite simply to see what happened in reality and to what extent, and judge how the strategic initiative (its outcome) compared with the level achieved in the scenario. This is complicated by the long-term approach upon which scenario planning is based.

A successful example during the Corona pandemic is the grocery store chains that managed to re-allocate resources to e-commerce. Afterwards they were able to evaluate whether they should have allocated even more resources to digital sales.

TOOLS FOR UNDERSTANDING THE FUTURE

Today, digital tools for planning, reporting and analysis are strategic tools which enable us to understand whether or not the right prerequisites exist for us to achieve the right results. The goal is to integrate everything into the other internal solutions, in order to get the relevant information to the right person as quickly as possible.

The tool should also be connected externally so that one’s own information can be enriched by data from other sources. Here, visualisation, automation and user-friendly systems are crucial.

It is not enough, however, to collect all the information in one place. You also need to be able to draw the right conclusions in order to be able to transform the information into valuable decision-making information.

Financial planning has acquired an even greater focus internally in the context of tools – and it has developed to include KPI’s and data from all parts of the operation.

Relying on Excel models or solutions which do not deal with changing preconditions is no longer accepted. Oddly enough, it was relatively common only 5 years ago, even among the larger listed companies. But as conditions and the business environment became increasingly unpredictable, the question of forcasting systems was raised on the agendas of management teams and board's.