2. What Is Scenario Analysis?
What Is Scenario Analysis?
• Scenario analysis is a technique that provides a rational and structured way
to analyze the future. Businesses can use it to examine different potential
impacts of negative and positive events, such as:
• What are the possible impacts on the business of an economic slowdown?
• What happens to revenue and profitability if the cost of various raw
materials rises?
• What revenues might be generated by a new product line?
• How would the business be impacted by the unexpected market entry of
new competitors?
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3. What Is Scenario Analysis?
• Scenario analysis examines a spectrum of different potential situations and outcomes,
typically ranging from a best-case to worst-case scenario.
• Businesses can then conduct scenario planning to better prepare for these events and
their potential impacts.
• Pioneered by the U.S. military during the mid-1900s, and Shell Oil started using it during
the 1970s to analyze and respond to fluctuations in global oil supplies.
• widely used by businesses, different financial modelling are used to make the process
much faster.
• more important for small businesses than for larger ones, since smaller companies may
be more heavily impacted by a single event.
• Scenario analysis is employed by financial services companies to analyze risks and make
investment decisions, and it can even be used to analyze household finances.
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4. Why Businesses Need Scenario Analysis
• To handle the Changes that impact the business environment unexpectedly
and suddenly—as demonstrated in magnified ways by the global pandemic
in 2020.
• Scenario analysis allows organizations to analyze and quantify potential
business impacts of such events, so they can plan accordingly.
• Used to assess the benefit and risks of different business decisions, for
example potential impact on revenue and profitability of building new
facilities.
• It helps businesses avoid diving blindly into a risky investment or project.
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5. Types of Scenarios
• A scenario analysis generally considers at least three types of
scenarios:
1. Base-case scenario: A baseline scenario based on current, commonly
accepted assumptions.
2. Worst-case scenario: The most negative set of assumptions.
3. Best-case scenario: The ideal projected scenario to achieve goals and
objectives.
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6. Types of Scenarios
• For example, in Kooky Cooks’ best-case scenario, revenues might actually rise
because people stay at home and do more cooking instead of eating out. In the
worst-case scenario, demand falls while all costs rise. In the base case, current trends
continue into the future. Each of these scenarios has a different impact on revenue
and profit.
• Examining a range of scenarios provides the company with a range of possible
outcomes for planning purposes.
• For example, the best-case scenario might result in a net profit margin of 20%, while
the worst-case scenario results in a margin of 5%. The company uses the range of
5%-20% to guide its decisions about investing in the manufacture of new products.
• A company may also assign probabilities to each scenario, based on its assessment
of the likelihood that it will occur. This can help to guide the company’s subsequent
planning and decisions about how to allocate resources.
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7. Types of Scenarios
• Multiple scenario analysis: Scenario analysis doesn’t have to be
restricted to just three possible cases. A company may consider many
different scenarios, each using a different set of assumptions. The
tradeoff is more scenarios require more effort to analyze them.
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8. Benefits of Scenario Analysis
• Key benefits of scenario analysis include:
• It helps companies manage risks more proactively by assessing the
impact of potential future events and situations.
• It can help businesses make better decisions by investigating the risks
and benefits of different options.
• The methodical approach to analyzing the future may enable
companies to spot opportunities or risks that might otherwise be
overlooked.
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9. Challenges of Scenario Analysis
• Scenario analysis can be a time-consuming process that requires
specific skills and expertise, although modeling tools can help.
• It can be difficult to envision all possible scenarios, make realistic
assumptions and assign probabilities to them.
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10. 6 Steps to Perform a Scenario Analysis
• Taking a methodical approach to scenario analysis can help to ensure that the
company focuses on the most important scenarios, considers the most relevant
factors, and gets the most benefit from the process. Here are six key steps:
1. Define the issue and the decisions that you need to make.
2. Gather data and identify key factors, trends and uncertainties that may affect the
plan. This may include external factors such as market shifts, political changes,
competitive threats and trends in customer behavior. It may also include internal
factors such as the company’s key strengths and development capabilities.
3. Develop a scenario planning template. This is generally a financial model (see
below) that enables the company to plug in various assumptions and examine
the impact on key metrics such as revenue or net income.
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11. 6 Steps to Perform a Scenario Analysis
4. Develop scenarios. Develop base-, worst- and best-case scenarios,
plus others if desired. To get the broadest view of potential scenarios
and assumptions it’s important to involve people with relevant
knowledge across the organization. This can also help avoid unconscious
bias and potential blind spots.
5. Evaluate the scenarios. Analyze the potential impact of each scenario.
6. Plan accordingly. Use the scenarios you have developed in your
planning, weighing the most likely risks and rewards.
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12. What is Scenario Modeling?
• Scenario analysis generally captures a range of possible outcomes that
will help ensure agility, business continuity and growth.
• In times of uncertainty, scenario modeling helps businesses build
models that allow them to assess the impact of their business plans on
revenue, expenses and cash flow.
• Originally, the calculations were performed manually. Now, companies
can use a variety of tools, from spreadsheets to sophisticated
modeling software that is integrated with financial and operational
source systems.
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13. Using Financial Modeling Tools for Scenario
Analysis
• In the past, scenario analysis was an extremely labor-intensive manual
process. Typically, it involved manually gathering data from disparate
sources inside and outside the company and entering the data into custom-
built spreadsheet-based financial models.
• The value of these models was limited by a variety of factors, including the
staff’s spreadsheet expertise and the ability to gather information that was
both comprehensive and up to date.
• Also, when the financial modeling process is static, it’s difficult to run what-if
scenarios for exploring multiple options.
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14. Using Financial Modeling Tools for Scenario
Analysis
• Modern financial modeling tools make scenario analysis much faster and
easier for companies of any size.
• For example, tools that are integrated with enterprise resource planning
(ERP) systems can pull in current and historical financial and operational
data which increases data integrity by eliminating the need to transfer data
manually.
• Preconfigured scenario analysis templates make it much easier to build
models.
• These tools greatly reduce the effort required for analysis, making it feasible
to conduct scenario analysis on a regular basis and apply it to more
situations, including smaller day-to-day operational decisions and issues.
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15. How to Do Scenario Modeling
• Generally, a company will include assumptions such as pricing, operating
costs, inflation, customer data, interest rates, and other metrics that could
impact the business.
• As a guide from the NYU Stern School of Business states, organizations
typically begin scenario modeling with three scenarios:
• 1. List all the assumptions for each scenario:
• 2. Put all the assumptions into a spreadsheet:
• 3. Build a section on the spreadsheet for a live scenario:
• 4. Test various scenarios and create scenario-based plans:
• 5. Test, implement, analyze, and adapt:
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16. How to Do Scenario Modeling
• 1. List all the assumptions for each scenario:
• For instance, if you run a manufacturing business, you can make
assumptions for the following:
• Revenue growth
• Cost of goods
• Salaries and benefits
• Rent and overhead, including inventory levels
• Depreciation and amortization
• Net margins
• These assumptions all can vary. How they change can impact your business
and your decision-making.
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17. How to Do Scenario Modeling
• 2. Put all the assumptions into a spreadsheet:
• Copy and paste for each scenario. You may have five scenarios or
more. It depends on your organization, all the variables at play, and all
the potential decisions you could make.
• 3. Build a section on the spreadsheet for a live scenario:
• This is for real-time updates of data. You can reference your scenario
models to see how to respond to the ever-changing situation on the
ground.
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18. How to Do Scenario Modeling
• 4. Test various scenarios and create scenario-based plans:
• This will enable you to answer high-level questions, such as:
• Should we take a business loan at a 6% APR?
• Should we invest the capital to enter a new market?
• What do we do if sales come in lower than expected?
• Does it make sense to raise the price of our services by 5%?
• How can we make up revenue if customer retention rates drop by
10%?
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19. How to Do Scenario Modeling
• 5. Test, implement, analyze, and adapt:
• Scenario modeling and financial modeling should never be static. It
should be a dynamic model that allows you to test a wide range of
scenarios in real time.
• This way, you can adapt to what’s happening and move forward in the
best possible manner.
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20. An Example of Scenario Modeling
• A small liberal arts college wants to enhance the student experience while
improving financial sustainability. This requires that they examine a variety
of pricing models, including:
• A tuition price reset: Simply lower or raise the tuition.
• Inflation price model: Adjust the tuition for inflation each year.
• Tuition promise model: Keep tuition the same for all four years for each new
class of students.
• Three-year degree: Offer the chance to graduate earlier by taking extra
classes (and therefore pay less overall).
• Continuing student scholarships: Students get financial aid, or a tuition
discount, if they get a good GPA.
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21. An Example of Scenario Modeling
• For the college, this goes beyond simple tuition model adjustments. The college wants to combine
one of these tuition models with marketable initiatives that would improve the student experience.
These initiatives include:
• Providing financial counseling to students and boost transparency in college pricing
• A graduation guarantee for students who meet academic expectations
• A high-impact stipend for high-performing students to study abroad, do research, etc.
• A subsidy for an interim experience
• More affordable study-abroad options
• To perform a compelling scenario analysis, the college would first determine their baseline, so they
can contrast different choices and outcomes. After that, they need to calculate all possible
scenarios to determine the best possible course of action.
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22. An Example of Scenario Modeling
• This involves calculating a lot of combinations and permutations,
which is much easier said than done. But running through all possible
scenarios ensures that the college will make the best decision
possible—the one that increases student enrollment and retention
rates.
• Scenario modeling illustrates that increasing tuition by 10% in the first
year and then reducing to a 3.3% increase in the following years is the
best tuition model to follow. It also shows this tuition model works
best when paired with student scholarships, stipends, a graduation
guarantee, and financial counseling.
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24. Business Scenario Analysis Use Cases
1. Re-configuring the service offering.
• Organisations are thinking outside the box to stay afloat; many had to
reconfigure the way they do business, the services they offer, and delivery
methods. In-person service delivery has shifted to the digital world: sales
meetings, employee training, education, and medical consultations to name
just a few. Leveraging scenario analysis tools to re-imagine the service delivery
and to model the impact on the P&L can help executives to project possible
outcomes and make informed decisions.
• Read all cases at https://blog.pa.com.au/business-management/budgeting-and-
forecasting/5-business-scenario-analysis-use-cases/
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25. Case Studies
• 1. Saving money by predicting who will quit
• 2. Achieving an optimum staffing level
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