Real-Time, Dynamic Scenario Planning
How treasury and finance teams can incorporate more flexible and comprehensive scenario analysis into planning and forecasting processes.
The fast, highly disruptive pace of the Covid-19 pandemic has forced organizations to rethink their traditional approaches to financial planning, modeling, and risk management. Treasury and finance teams are navigating toward an uncertain future by using diverse sets of real-time data to gauge the impacts of different “what-if” scenarios on corporate performance. However, the complexity of today’s market conditions, not to mention the pandemic’s evolving impacts on business drivers, makes the standard scenario analysis process unreliable.
The global crisis has revealed the need for treasurers and CFOs to embrace a new, more robust approach to managing complexity in real time. This means making proactive, permanent changes to their forecasting, planning, and analysis processes. Why? Because the financial models of the past are no longer relevant. Finance teams cannot succeed if they think in terms of quarters and years; instead, they need to be planning their response to projected conditions in the coming months or even weeks.
As market and business volatility continues, finance and risk leaders will be at a major disadvantage if they don’t leverage dynamic scenario planning. Characterized by real-time modeling techniques and rapid simulations, this approach helps treasury and finance professionals better predict and plan for future challenges. Dynamic scenario planning leverages predictive internal and external financial data. The resulting strategic action plans stand up to disruption and macroeconomic risks, and they identify opportunities for revenue growth, while optimizing customer and supplier relationships.
Shift to New Time Horizons
Last spring, companies all over the world discovered that annual budgets and forecasts formed before the Covid-19 crisis became almost irrelevant over the course of a few months. By the end of June, more than 40 percent of S&P 500 companies had pulled their guidance, presumably in response to the realization that traditional methods of financial planning are ineffective when the external world is so unpredictable.
However, ceasing to develop financial plans is not an option, even for companies that stop providing external guidance. Many treasury and finance teams have used the pandemic economy as motivation to rethink their processes for developing the forecasts that drive management decisions. One of the most important lessons these groups learned is that their forecasts should include an assortment of time horizons.
Planning three to six months ahead often makes sense in supporting key decisions about sales, staffing, cash flow, and the company’s supply chain and distribution. However, to overcome uncertainty, businesses should simultaneously aim to develop shorter-term forecasts that provide insight into solving short-term challenges. They should also generally deliver durable (but flexible) plans for investors that account for the next year and beyond.
Approaches for selecting the appropriate time horizons for forecasts vary widely depending on industry, geography, and other factors. Still, two things are certain across businesses of all types. First, the 12-month financial forecasts should include multiple alternative scenarios for the initial three months. At the moment, that would mean different scenarios representing the possible speeds at which the current economic disruption might begin to subside. And second, the treasury and finance teams must have a process for updating forecasts based on the variance between what was expected (forecasts) and what occurred (actuals).
It’s also important to keep in mind that an organization’s financial plans for the immediate term (up to 90 days out), the near future (three months to a year), and farther out are, necessarily, interlocked and interdependent. Shortsighted plans that focus merely on the near term will fail to take longer-term trends into consideration. As a result, they will likely fall short on delivering longer-term success—which in the current environment means recovery. And that’s a serious concern for organizations that aim to rebound from the crisis stronger than they were before.
Discovering Divergences
Treasurers, CFOs, and their teams are now tasked with identifying and analyzing where their business’s performance has most widely diverged from their original financial forecasts. In other words, they’re taking a good, hard look at what changed due to the pandemic and what their path forward should be.
At a macro level, these analyses should reveal that Covid-19 has not dramatically changed the primary factors driving the business’s success. On a more localized scale, however, the crisis has ignited a flurry of new forces that are affecting organizational performance, and they tend to be specific to the product or service offered. In some industries, these new forces are deeply impacting business performance—for example, ongoing layoffs may drive up the number of loan defaults and late credit card payments in the financial services industry.
In response, companies are scrambling to identify where their finances have experienced the greatest divergences from their original forecasts. This essential step can help treasury and finance teams understand where they may be able to free up or gain value—and where value was lost. It can also reveal the root causes of why actuals differed from the original plan. Meanwhile, as they uncover these differences, companies can begin addressing any new factors that they’re up against, such as government regulations, supply-chain disruptions, and changing consumer behavior, to name a few.
Unfortunately, treasury and finance teams often undertake these analyses without the tools they need. Planning for the pandemic recovery requires an effective assessment of the impacts that myriad variables have on financial outcomes, at a high level of granularity and at regularly scheduled intervals (monthly, weekly, or even daily). Once the economy has normalized, making this type of divergence analysis a routine part of corporate financial management will continue to provide a strong foundation for stable planning mechanisms and systems going forward.
4 Components of a Dynamic Planning Model
The fast, accurate dynamic scenario planning model that treasury and finance teams need in the current economic climate encompasses four key elements:
1. Diverse data. A dynamic planning process leverages the power of diverse data—both internal company data and external market data. It pulls a great deal of data into analytics tools, which replace tedious spreadsheets and workbooks, allowing for swift modeling of multiple options and factors. Companies that utilize cloud-based tools for this purpose gain the additional benefit of easy sharing of analyses and results among finance teams worldwide.
Pulling a broad set of data into more effective, less labor-intensive analysis tools enables treasury and finance teams to identify actual performance drivers. In the pandemic climate, they can better understand what the company’s new financial baseline is and how different elements in the model work together. This leads to a greater understanding of the impact of all the variables on different planning scenarios—such as liquidity modeling and what-if scenarios—which, in turn, helps finance and operations align on the best path forward.
For example, per a recent Accenture case study, the CFO and finance, planning, and accounting teams at a large media company jointly used SAP Analytics Cloud to inform an interactive discussion with their board of directors about the business’s long-term plan. Before the meeting, the finance team set up a baseline plan as well as different growth scenarios. Then, during the conversation with the board, they were able to dynamically adjust key inputs, such as macroeconomic indicators and cash inflows for different business units. This provided an immediate view of how the changes to inputs would affect output metrics, such as revenue growth rate, margins, and adjusted earnings per share. This new, dynamic-scenario–based process sped up alignment among the board, the C-suite, and business-unit leaders on the long-term strategic plan, enabling the company to quickly prioritize crucial investment decisions.
2. Insights and intelligence. Artificial intelligence (AI) and machine learning (ML) algorithms enable finance solutions to generate dynamic scenario models that can find correlations between variables (including both internal and external data) or trigger specific actions when values fall outside certain parameters. Such modeling helps treasury, finance, and risk leaders quickly understand the causal relationships between the company’s unique internal business drivers and broader macroeconomic indicators.
These insights can guide organizations through times of crisis. They also help treasury and finance teams identify changes they may need to make in the future, including alterations to how the company attracts and retains customers, manages costs, and goes to market.
3. Talent. Achieving the aforementioned insights with minimal manual effort—i.e., via AI- or ML-driven “intelligent” solutions rather than through data manipulation in spreadsheets—frees up treasury and finance staff to focus on business partnerships and more strategic work. Leaders in these functions need to focus on having the right talent and skills for the new workloads. In some companies, that may mean shifting desired skill sets from lower-level data entry and analysis positions to hiring more data scientists and data engineers.
Leadership should also focus on helping treasury and finance analysts, and other staff, better understand the business. Doing so can help them connect seamlessly with the rest of the organization and communicate more effectively with business teams about various scenario models and the details of the financial forecasts. Ideally, the result will be that business groups provide better inputs to the planning process, because they understand how to adjust prior years’ actuals to reflect trends in external data, rather than simply basing forecasts on their own assumptions about the business’s trajectory.
4. An intelligent cloud-based platform. Finance functions that pursue diverse skill sets in their workforce and blurred boundaries between departments need a sophisticated and widely accessible software platform to ensure smooth work orchestration. Some cloud-based solutions that are now available were built to drive more connected planning, forecasting, and scenario modeling, in order to accelerate decision-making via better insights and cross-functional collaboration. Their intelligent finance operating models leverage data and emerging technologies such as machine learning and AI to give leaders real-time data they can act on and help drive sustainable growth.
Operationalizing Change
It’s unavoidable: Major fluctuations in how companies manage customer and supplier relationships, maintain adequate levels of liquidity, and predict customer demand will continue to shift rapidly in regions around the world. In this environment, effective decision-making requires agile processes and powerful software solutions that bring to life real-time, dynamic scenario planning. The design of such a treasury and finance infrastructure should incorporate input from experts across the organization.
A treasury or finance leader looking to spark the transition to dynamic scenario planning should start by establishing a planning task force that brings together experts from every function of the organization. This group should focus on identifying changes in the key drivers that impact the company’s financial statements, as well as trends in its customer base and industry. The task force should leverage timely, relevant data and sophisticated analytics to understand the business’s rapidly shifting situation. Then, the treasury and finance groups can use the collective insights that come out of the task force to update scenario modeling and financial forecasts to prepare for disruption—now and in the future.
For the longer term, treasury groups should consider establishing a liquidity control tower, an agile group of cross-functional, interdisciplinary teams assembled for the purpose of providing leadership with a single, harmonized view of corporate liquidity. The liquidity control tower must be empowered to collect and interpret information about receivables, payables, inventory, risk, tax, and cash flows throughout the organization.
When it has access to the right financial data points, a liquidity control tower can use dynamic scenario planning to model working capital pain points—to predict, for instance, which invoices are most likely to be paid late or be subject to dispute. Likewise, a liquidity control tower can identify approaches to optimize corporate spending, perhaps analyzing open purchase orders with an eye toward reducing nonessential spending or identifying opportunities to renegotiate payment terms. And a liquidity control tower that leverages real-time, dynamic scenario planning can provide management with full end-to-end visibility into the effects of prospective cash management decisions.
Corporate treasurers and CFOs in today’s business climate are tasked with securing and strengthening the organization’s liquidity. The critical insights developed by a liquidity control tower—and by other staff effectively leveraging dynamic scenario planning—can help treasury and finance leaders establish financial targets and action plans, communicate and coordinate with operations groups, drive needed change, allocate resources, and explain to business stakeholders the measures the company is taking to shore up liquidity and the outcomes of those actions.
Companies vying to remain relevant and achieve business continuity while fighting an unrelenting tide of change are turning to dynamic scenario planning as an effective solution. This strategy not only shores up much-needed opportunities for sustainable growth, it also helps organizations outmaneuver uncertainty.