COVID-19 is a serious public health concern that’s taken a huge toll on businesses and industries around the globe.
In this article, we’ll share tips from our latest webinar with Jack Alexander on how to use scenario planning and cash flow management to navigate through today’s uncertain economic climate. Watch the full webinar here for more details.
1. Focusing on the facts
Understanding the facts and data behind COVID-19 is extremely important to help you make sense of the pandemic and plan for it accordingly.
Unfortunately, staying clear-headed and fact-focused during times of crisis can be difficult. To help you get clarity on the COVID-19 pandemic (and any other crisis your business may face in the future), we recommend putting together fact sheets/dashboards to paint a clearer picture of the extent of the crisis.
For COVID-19, an obvious place to start is to track the confirmed cases of the virus in your country and any other countries you do business in. Remember to break down these numbers by state/region to get a clearer picture of how localized the virus is and how it might affect your operations.
However, keep in mind that many of these figures are lagging indicators. That means they don’t offer insight into what’s happening at present, nor what’s likely to happen in the future. Unfortunately, with COVID-19 and most crisis situations, uncertainty is the only certainty.
2. Embracing scenario planning
As finance professionals, one of our biggest challenges is helping organizations prepare for the future. Unfortunately, even the biggest finance departments still aren’t equipped with crystal balls allowing us to see 3, 6, or 12 months ahead of time.
Most traditional financial plans are based on a single-point forecast. Trend analysis, the backbone of traditional forecasting, for example, is based on the assumption that the future will likely look like the past.
There are countless pitfalls to this kind of financial planning; it’s biased and ignores uncertainty; it’s based on dozens of critical assumptions (many of which are buried in Excel formulas), and it provides a false sense of security and encourages groupthink decision making.
That’s where scenario planning comes in: “The human mind has difficulty making decisions involving uncertainty. Scenario Planning is a tool that assists us in making structured decisions in uncertain situations,” says Jack Alexander. Unlike traditional planning methods, scenario analysis allows us to grasp the big picture of how our business would be affected under certain circumstances.
The budgets and other traditional strategic plans in your finance arsenal tend to work by focusing on changes to single metrics like revenue, production costs, or cash flow. Scenario analysis, on the other hand, works by outlining detailed scenarios and tries to paint a more comprehensive picture of how each scenario would affect the key drivers of your business.
“In the case of contemplating a recession, for example, a Scenario Analysis would take into account the effects the recession has on multiple variables like unit volume, pricing, human capital turnover, compensation, and more,” says Jack Alexander.
In doing so, scenario analysis provides a much deeper insight into your company’s performance and how it might be affected by complex, real-life situations.
Under the COVID-19 pandemic, for example, the US may be faced with a recession (as is the case in many other regions that, until now, enjoyed steady, slow economic growth). Scenario Planning allows us to draw up a plan of how a recession would affect the key drivers of our company, such as unit volume, pricing, competition, human capital turnover, supply chains, compensation, and much more. Unlike other planning methodologies, scenario analysis allows us to project the total impact a particular scenario will have on our firm.
The steps of a successful scenario analysis, in short, include:
- Identifying the key assumptions underlying our forecasts and clearing presenting them in a robust planning model.
- Developing a base case.
- Identifying and modeling roughly 3-7 alternative scenarios and estimating their likelihood.
- Monitoring the critical assumptions listed in step 1 via a dashboard.
- Narrowing down and refining scenarios based as events play out.
Best practices for incorporating Scenario Analysis into your planning processes
Incorporating scenario analysis into your planning is vital. However, it can be challenging for financial planners to understand just how to implement this strategy properly.
It’s all well and good to brainstorm a bunch of potential scenarios, but how do you know which ones are actually focusing and how to prepare for them adequately?
Well, we recommend starting with a base case. This can be the scenario that seems most likely based on trend analysis. Make sure to clearly identify the key assumptions leveraging this projection, and also outline how it would affect all of your company’s key drivers.
Next, you’ll want to start brainstorming other potential scenarios. To do so, it helps to work with a multidisciplinary team of people, not just members of your company’s finance team.
For each of these new scenarios, you’ll then want to:
- Provide a clear description of the event and the likelihood of it happening.
- Highlight the impact the scenario would have on your company’s key drivers.
- List some key indicators of the event occurring.
- Highlight a clear trigger event that marks the event is about to take place.
From there, you and your team will want to prepare detailed management responses for each scenario. It’s critical that, for each of these scenarios, you outline what actions your company should take before, after, and at the time of the trigger event.
Remember, there’s likely no shortage of scenarios you and your team can come up with. To maximize your resources, some FPA experts suggest medium-sized businesses stick to brainstorming only 3-4 scenarios. Shell, on the other hand, encourages leaders to stretch their thinking and even consider scenarios that might seem only remotely possible.
We believe that the number of scenarios you prepare for depends largely on the size of your organization, its scope, and resources. In general, we recommend spending less time on the best and worst-case scenarios, as they tend to be very obvious and don’t really encourage your team to think outside of the box.
3. Remember: cash is king
“Cash flow is the basis for creating value and the fuel for operating and growing your business,” says Jack. During times of crisis, understanding the dynamics of your company’s cash flow and identifying ways to preserve cash is essential.
There are basically 2 ways to monitor cash flow, and your company needs to master both:
- Indirect cash projections, while not ideal for managing short term cash flow during times of crisis, is a necessary tool for communicating with external stakeholders, investors, or banks, especially if you want to increase your credit line.
- Direct cash projections are great for managing and assessing short-term cash flow. They provide rich insight into your company’s flow of cash and ways to improve it. Direct cash flow statements are also extremely intuitive and strongly resemble how you would manage your personal finances or balance checkbooks.
Besides these projections, your finance team will also need to keep close tabs on your working capital (which are almost always driven by cash collections and payments) and set estimates for your liquidity needs. More importantly, Jack also highly recommends estimating the impact a crisis like COVID-19 will have on your company’s revenue.
“Even during good times, accurately estimating revenue is very challenging,” says Jack. For a clearer picture of how your business’ revenue will be affected by a crisis like Coronavirus, think of the nature of your service or product, the means of its distribution, and how its sales may be affected (positively or negatively) in each of your scenario plans.
We recently held a webinar with Jack focused specifically on improving cash flow and working capital management. Make sure to check it out for more details and stay tuned for more webinars like this.