Scenario planning – A cornerstone of FP&A in the world of COVID-19

COVID-19 brought global business to a standstill. With the world’s second-largest economy in lockdown and strict quarantine restrictions in place all over the globe, businesses were suddenly thrown into the deep end of crisis planning.

In March 2020, as part of an in-depth look at the business implications of COVID-19, we predicted that scenario planning would offer businesses the best way to prepare for the uncertainty of the global pandemic.

For the second time in the last 12 months, management consultant giant McKinsey and Company has confirmed that prediction in their latest article on how to prepare for the “new normal” in the wake of COVID-19.

Scenario planning is vital for proper cash flow management in times of uncertainty

Over 12 months have passed since COVID-19 was identified in Wuhan, China. And how the pandemic continues to evolve is still a guessing game. Luckily, scenario planning is helping businesses face that uncertainty.

As part of its CFO pulse survey (which interviewed CFOs from leading companies around the world), McKinsey found that 90% of CFOs are now using at least 3-way scenario analysis in their planning models.

Results from the survey also highlighted a stark change in attitude towards scenario planning. Prior to the COVID-19 pandemic, McKinsey found that CFOs often saw scenario analysis as a “stimulating, intellectual, and thought-provoking exercise…but not one with a clear business impact.”

McKinsey’s latest survey data, however, shows that scenario analysis has become a cornerstone of the FP&A processes employed by many companies. More specifically, its survey results show that scenario-planning is proving particularly important in cash flow management.

Over 40% of respondents to the McKinsey survey said they dedicated a considerable portion of their crisis management efforts to “scenario-based cash planning,” while over 70% said they will hold back reasonable amounts of cash as a result of scenario analysis.

Five best practices for planning for the “new normal”

Unfortunately, it’s not all roses when it comes to incorporating scenario planning into your financial model. McKinsey’s survey results highlight that many organizations, especially those in the finance sector (which rely on longer-term plans than other cash-constrained businesses), are still struggling to adopt scenario analysis into their planning.

To help businesses adopt the agility needed to run a functional scenario analysis, McKinsey and Company came up with the following best practices:

  • Describe drastically different scenarios. Make sure your plan incorporates scenarios that describe future states that imply drastically different impacts on your business.
  • Keep it simple. Many companies fall into the trap of trying to elaborate overly-complicated scenario models. Ideally, you’ll want to identify just a few variables that will drastically affect the key drivers of your business for each scenario. McKinsey also recommends only simulating financial line items to avoid redundancy.
  • Clearly identify action plans. Remember to create a well-defined action plan for each scenario that focuses on addressing changes to the key variables affecting your organization’s main business drivers.
  • Going into the right amount of detail. Your scenario analysis should be detailed enough to highlight the specific impacts a scenario has on your business and clearly outline a response plan. Managing this level of detail will vary for each company depending on its size and sector.

Learn more about the power of scenario planning

The COVID-19 pandemic has created a unique economic environment ruled by uncertainty. Scenario planning, however, offers an agile and flexible way to explore how drastic changes in your company’s economic microclimate will affect the key areas of its operations and, more importantly, how to deal with those situations.

For more info, make sure to bookmark our blog and check out our previous articles.

For the full McKinsey report, click here.

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