The deep and broad implications of COVID-19 are forcing businesses to make significant decisions under extreme time pressure and substantial uncertainty. With so much unknown, are those businesses confident that they have sufficient and reliable information to support their judgements? If not, what can be done to help businesses to make more informed decisions?
In our experience, it is vital that businesses undertake robust scenario planning to be able to clearly demonstrate financial viability to stakeholders. In order to develop the detailed, data driven scenarios required to inform these discussions, it is likely that businesses will turn to existing operational and forecasting models to support this process. In this article, we will briefly explore five model design considerations that can be quickly implemented into existing models that will help improve businesses’ capability for scenario planning so that they are able to answer the following questions more confidently:
What is the base case or ‘most likely’ scenario?
Whilst outlining a ‘most likely’ scenario is very difficult in the COVID-19 era, it is first necessary to outline both the current and near-term position of the business. This scenario should bring together the financial impacts of all actions that have been taken to date and clearly show the expected outcome if no further actions were taken. This is achieved by utilising data and insights to create an evidence based best-case scenario.
To allow the base case scenario to be developed and agreed at pace, existing operational or forecasting models can be used as the basis for forecasting. However, these models may be inflexible or lack clarity in areas which are not normally included during the regular budgeting process. Therefore, risk areas need to be identified quickly. Risk areas would include those areas where limited detail is included during the budgeting process, but which are now more important in the current situation. These areas should be reviewed, and additional bottom-up calculations added where necessary to support the base case scenario.
What range of scenarios should be considered?
Next, thoughts must turn to the range of scenarios that need to be evaluated, as well as the triggers that may crystallise specific scenarios.
In situations as dynamic and evolving as the current crisis the problem can often be that there are simply too many contradictory scenarios to consider in the time available. Therefore, businesses should consider which scenarios best represent reasonable but significant variations from the base case, understand the differences between these scenarios and aim to distil these down into a manageable number (2 or 3) which can then be developed with sufficient detail to provide informative outputs.
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The model will need to be adjusted in order to provide flexibility across the inputs for critical assumptions in order to allow the business to quickly and consistently assess different scenarios and their impact on outcomes. With adjusted flexibility, numerous inputs can be tested to support the process of fine tuning the scenario and focusing on more influential inputs.
Building a dashboard to extract important datapoints from the model will help the user to understand and interpret the impact of changes to specific assumptions. Multiple strategic options can then be assessed with consistent outputs provided to management to enable comparison on a like for like basis.
What levers can be pulled?
When analysing and assessing the scenarios chosen, it is necessary to consider the viability of contingency plans for each scenario. In particular, businesses must consider what levers are available for them to pull to impact the outcome of each scenario, how quickly the impact of these changes will be achieved and what resources may be required to deliver them. Critical internal and external commercial and operational dependencies must also be considered. Examples of levers available will vary greatly by sector and individual business, but including operational restructuring, drawing upon debt facilities and workforce optimisation.
Incorporating flexible scenario modules into existing operating models can help to quantify sensitivities and the impact of different internal and external factors on the business and enable quick evaluation of the impact on business viability.
Working through the process of integrating the scenario module will likely generate questions regarding how items should be woven into the current structure, highlighting to management early on where there may be interdependencies that hadn’t previously been considered.
Is each scenario financially viable?
Once developed, the business will need to evaluate the financial viability of each scenario and what support would be needed to achieve this. They will need to be able to quantify the funding need that each scenario creates in order to start to consider pricing options and possible covenants. There may also be other critical issues which come to light and will need to be addressed with urgency for each scenario.
Where models are insufficiently flexible to evaluate the financing structure, funding modules may be overlaid into the existing model in order to quantify the funding needs. This provides insight to both the company and lenders and enables the evaluation of pricing options.
Integrating scenario analysis into the funding module also allows the running of multiple, custom built refinancing scenarios at the click of a button.
How will different stakeholders be impacted?
It is important that through this process, businesses are able to demonstrate that the scenario planning analysis has been carried out at sufficient depth and provides sufficient clarity to demonstrate that stakeholders are protected and that the business is worthy of continued or additional support.
Adjusting an operational model to become a robust and transparent strategic scenario planning model will provide an appropriate level of insight into options and support immediate business continuity decisions. Creating a flexible model, able to run sensitivity analysis and provide consistent and comparable outputs, will enable the business to clearly demonstrate the considerations that they have made as well as evaluate stress testing of both macroeconomic and industry specific factors.
These steps will help to support businesses to make the difficult decisions required during this time of crisis. By adjusting existing forecasting models this can be done at the pace required to meet the challenges of today’s difficult business environment.
For insights and materials on responding to the business impacts of COVID-19, please visit: ey.com/uk/covid