For many CFOs, the end of the fiscal year is quickly approaching, which means your plans have been drafted, circulated, debated and approved based on the goals the executive team set for the company in 2019. But let’s face it. All plans, to a certain extent, are based on assumptions.
If you’re like most CFOs I speak to, there’s a voice in your head that keeps asking: How accurate are those assumptions? Where are the weaknesses? How can I prepare the company for them should an issue arise?
If peace of mind is a goal, I suggest conducting some stress tests of your plan. There are three ways to go about it; the right approach depends on the number of variables you want to test, and whether the factors are within your control our outside of it.
Sensitivity Analysis
Sensitivity analysis answers the question: how sensitive is the plan to a specific internal or external variable? For instance, if your plan calls for a 20 percent increase in sales, but you only achieve a 15 percent lift, what is the impact on your P&L, cash flow statement and balance sheet?
Sensitivity analysis only changes a number in a column — an increase in interest rates or higher insurance rates — and not the plan itself. All of the structures you built into the plan remain the same, which means this stress test is relatively easy to do. It’s a good way to spot potential issues, update your rolling forecast and warn the executive team or board of directors if necessary.
Scenario Planning and Goal Alignment
Your plan details your goals as well as how you’ll go about achieving them. For instance, you may decide to open more offices along the East Coast, where sales have been strong and the average order value is high.
But what happens if the CEO decides to open an office in San Francisco instead, in order to test the waters? Or if the board of directors decides it’s better to use those resources to develop and release a new product by the end of the year instead? In these cases, multiple variables come into play. In fact, your plan may need to change drastically. Rent and salaries are higher in the Bay Area, and your product line may need to be tweaked to meet the needs of that market. If your board prevails, you may need to hire engineers to meet their end-of-year date, which may mean higher recruitment costs and salaries.
Scenario planning allows you to test these ideas and assess their impact on your financial statements, but you will need a flexible planning tool, one that will allow you to make changes to your plans, and ensure all the inputs (rent, salaries, office supplies, product launch, etc.) automatically update your P&L, cash flow statement and balance sheet.
What-If: Planning against External Factors
There are numerous external factors that can upend (for good or for ill) the best-laid plans. Exchange rates, interest rates, the price of oil, or the entire economy can go up or down. Even catastrophic weather events can force you to rethink part of your plan. Obviously, these are factors you have no control over, but you can plan for them. That’s where what-if planning comes in.
What-if planning allows you to assess ahead of time the impact of external events on your financial statements. What-if planning can be defensive — how will we make our numbers in light of these developments? Or it can be offensive — how do we exploit a market opening created when a competitor was fined by the EU?
Getting into the habit of regularly stress testing your plan is a good idea, and not just because it will help you sleep better at night. It will force you to look at your assumptions and update your forecasts based on a host of internal and external factors. But it may also mean you need to upgrade your tools if you build your plan in Excel. You can easily do sensitivity testing with your spreadsheet, but scenario planning and what-if planning may require fundamental changes to your model, and you’ll need a lot more flexibility.
