In a recent blog post, we discussed the difference between cash flow forecasting and scenario planning. Scenario planning is conducted by changing key assumptions or business drivers of your cash flow forecast to see how this may affect future cash flow. It’s a ‘What If’ cash flow experience used to reduce uncertainty and provide confidence.
But how do you know when to run a scenario plan? Here are a few tips on how you can be prepared for any situation with scenario planning.
Guideline on dollar amounts
The first thing you need to know about scenario planning is when to run a scenario plan. Obviously, smaller purchases don’t warrant scenario planning, but what does? Only run a scenario plan on the large drivers of your business contributing to the biggest movement in income or cost. For example, income would include sales price and sale volume. Cost would include material costs, exchange rate, and casual labour costs. Cost also accounts for large capital purchases such as equipment or property.
If you are still unsure what numbers to run a scenario plan on, ask yourself, “If this number changes more than x%, can it: a) wipe out my margin, or b) take me beyond my working capital limit?” If your answer is yes, it’s in your best interest to run a scenario plan.
Events triggering scenario planning
Another important consideration is knowing what events require a scenario plan.
Examples of these events include:
- Loss in consumer/business confidence
- A blowout in your accounts receivables commonly precedes a general business downturn. It’s often an indicator your suppliers are having cash flow problems.
- Increasing or decreasing prices
- Capital expenditure
- Fluctuating dollar
- Fluctuating commodity prices
- Changes in government leadership
- World event that can increase or reduce supply
- Natural disaster, such as fire, flood or drought
- Political restrictions, such as tariffs or trade embargoes
- Winning or losing a big contract
- Increase or decrease in staff
- Changing product or service offering
These types of events are “known unknowns” and it’s essential to be ready when they occur. Preparing both structurally and mentally ensures the business deals with the situation calmly and effectively.
Time frame for scenario planning
When is the best time of the year to run scenario planning? Ideally, you want to schedule scenario planning at least once every six months. Scheduling regular scenario planning helps reduce stress, a factor contributing to poor decision making. It also ensures your business is prepared for every situation that may be thrown at it. While six months is a recommended time frame, every time you notice a significant change in your business, either internally or externally, you should run a scenario plan.
Having a scenario plan in place prepares your business for any situation. Reep has an excellent and easy way to conduct scenario planning for small businesses. Don’t be surprised if you get hooked. Have a look.