The following is an edited abstract from CFO Thought Leader’s “Ask Ethan” podcast featuring Ethan Carlson, CEO, Carlson Management Consulting, and Jack Sweeney, co-host of CFO Thought Leader.
CFOTL We’re often told that scenario planning is not about providing an accurate picture of the future, but about making decisions regarding the future. What exactly is being said here?
Ethan I think that the whole process around planning and budgeting and forecasting is a relatively inexact science. It’s kind of the art of finance. It’s not that adding in scenario planning is going to make your projections any more accurate. For me it’s an opportunity to think about what the possible outcomes are and work through what your firm’s reactions to those will be. I think about it as a sports team practicing before a game. You want to prepare for the things that might be thrown your way.
We all know that the future holds things that we can’t predict. If you can work through a series of scenarios involving your financials and how they might be impacted by various events and how you would react to those and you work as a management team, you’re going to react better on the spot when something unforeseen occurs.
CFOTL It seems to us that scenario planning could become an interesting assignment for a strategy-minded finance person — since it really requires finance to collaborate with different parts of the business to identify possible scenarios.
Ethan Well, I think that the point you raise is an excellent one in that it really is an opportunity for finance leaders who want to be involved in the business and understand what makes it really go and where the major risks are. It does present an opportunity. I don’t think I can say that we see this widely. I’ve always viewed finance and business interaction and the collaboration as a two-way street. This type of scenario planning represents that.
CFOTL Do you find that certain CFOs still do not view scenario planning as being a particularly practical use of time? That some view it as a burden that companies have to get past?
Ethan Sure, this could certainly become a huge time sinkhole and one that I could see plenty of financial leaders not seeing as valuable. If you have a model that you’ve constructed for your budget and for your forecast that has driver-based elements to it, I think that you can be very efficient, and quite honestly I think that if you’re not doing, at least, some level of scenario planning, your planning process is incomplete. You’ll want to make sure that you don’t run a hundred scenarios for all the possible things that can occur. If you’re not doing the three or four most likely variants of your budget or your forecast at any given time, it’s really, I think, incomplete.
I can think back to when I was running a forecast for a company and we would always have a best upside scenario and a downside scenario, and we understood what our levers were and that scenario planning is not always reacting to a negative, but it’s also reacting to the positive. If you all of a sudden have an influx of new business or new opportunity, how are you going to react to that as well? At a bare minimum, I would say that if you’re not doing those base three reviews, you’re incomplete in your process.
CFOTL Is there a set of common components that successful scenario planning initiatives have?
Ethan I think that it goes back to the model. First and foremost, you have to have a model that is going to be receptive to scenario planning. You have to have something that is driver-based. You have to have nonfinancial metrics as part of your projections because these will be the drivers of your financial results. I think that if you have these in place, it definitely helps. I also think that it in some ways you have to have a baseline that runs a couple of variants of your forecast at a time. I also think that where scenario planning kind of goes to the next level is when you start to evaluate all major decisions and see their impact through your full set of financials and key performance metrics when you’re prepared to, say, launch a new product or other initiative.
You’re able to plug in the variables associated with it and see how they cascade through your whole model on the spot, so that there’s a real-time shift. I think that scenario planning kind of starts as a point in time where you periodically are doing different scenarios. It becomes most successful when you then shift into that real-time analysis and are able to run them through your model and you see what the impact is. You’re no longer making decisions blindly.
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