Scenario modelling is now more important than ever before!
Amidst the pandemic, businesses should focus on forecasting and scenario planning to navigate through uncertainties. One way of doing this is to build scenarios into your financial model to evaluate future possible events and ascertain their impact on your business’s revenue, cashflow and overall operational profitability.
How is scenario modelling different from conventional financial modelling?
In conventional financial modelling, your forecasts are primarily based on the “most likely” future scenario and in some cases, only on the “best case” scenario.
Scenario modelling is much more complex than this, in the sense that, you do not only look into the “most likely” scenario. You predict an array of possible events that may occur in the future. For instance, if you are a restaurant, your model should be able to give you results under the following scenarios:
Scenario I: Government imposes shutdown of restaurants till end of 2021
Scenario II: Government imposes shutdown of restaurants till end of 2022
Scenario III: Removing indoor dining experiences completely from the business model and serving customers through home delivery only
Why is scenario modelling important?
Scenario planning can help your business be more proactive by being prepared to face anticipated possible outcomes. By being prepared for the “worst case” scenario, you can potentially avoid or cut down the losses that are likely to occur, should the scenario arise. Further, well-informed investment decisions can be made by understanding all possible financial results under different scenarios. Having a range of returns anticipated between the “best case” and the “worst case” scenarios can help businesses optimize decision-making.
So how do you do scenario modelling?
The most important step before you start modelling is identifying all possible scenarios that your business can face. Some of the questions that you can yourself include:
How far out in the future are you trying to predict?
What are the key internal drivers?
What are the major external factors that impact your business and overall industry that you operate in?
What are some of the potential risks/issues that can come up in your business?
Once the scenarios are set, the simplest way to approach scenario modelling is to start creating a fixed set of assumptions and assigning different values to each assumption under various scenarios in an excel spreadsheet.
Some of the excel functions that we typically use for scenario modelling include:
CHOOSE function
OFFSET/MATCH function with Data Validation
What If Analysis and Goal Seek
XLOOKUP function
Scenario planning can be time consuming and usually requires high-level of skills to be able to predict scenarios correctly and model them seamlessly. We are providing you with a few useful resources that can help you get started with the basics of scenario modelling:
At Falak, we specialize in financial modelling for businesses across a broad range of sectors. Our approach to financial modelling varies based on the size of the business that we’re dealing with and the industry the business operates in. We do not follow a template – we study all potential external and internal factors that may affect a business and build it into our models to give a realistic outlook.