Find more articles from this series here.
All types of business planning are important, but one particularly useful type—scenario planning—is too often overlooked by business owners, cautions David Worrell, managing partner of Charlotte, North Carolina-based Fuse Financial Partners and author of The Entrepreneur’s Guide to Financial Statements. “Scenario planning is a great way to anticipate the risks in your business and how you will adapt to them,” he says.
No one can predict the future with absolute certainty, but any business that doesn’t at least try to make educated guesses about what’s coming down the pike is shortchanging itself. One of the best ways to do that is through scenario planning that captures best-case, worst-case and most-likely growth projections.
“Scenario planning is not just for startups,” Worrell stresses. “The larger your business and the more complex it grows, the more important a good scenario-based model becomes.” Business owners who embrace scenario planning are going to make better decisions—the kinds of decisions that can catapult them past their competitors.
Scenario Planning Helps Innovative Entrepreneurs Mitigate Risk
Jenni Lough Watson is president of Swiftdogz, an innovative pet-services company based in Concord, North Carolina. With almost 20 years of experience in the pet grooming and training industry, she took the entrepreneurial leap in 2009, starting out in a 600-square-foot building located, she says, “off the beaten path.”
Swiftdogz provides its clients with traditional pet services such as grooming and boarding, but what sets it apart from competitors is Relative Space, a unique training methodology created by Lough Watson. “Relative Space empowers intentional decision-making in every interaction and enables dogs and their owners to enjoy life together, wherever they go,” she explains.
Four years after launch, Swiftdogz relocated into a new 2,000-square-foot facility in a prime retail location. Today, its workforce has grown to 15 employees—including five new hires in the past year alone—and it services a roster of 1,200 clients from 30 U.S. states and Canada. The company’s innovative training technique has driven much of that growth, but Lough Watson also incorporated scenario planning into her business strategy from the very start, and knows it played a role in helping to achieve her goals.
“Because we work through many scenarios before launching any change, we mitigate our risks and protect the business from abrupt changes in income or cash flow,” Lough Watson says. The foundation of that process is stringent maintenance of basic financials (P&L, cash projection and balance sheet) normalized to percent-of-income to make comparisons easier, she explains. “Every segment of the business has a set of income and expense accounts that we can use to guide decisions, and we measure everything at least quarterly. We think through every scenario ahead of time, so we can also uphold our promises to customers.”
Stress-Testing Your Business Model
In Worrell’s experience, most businesses enjoy running best-case scenarios, but it’s even more important to run worst-case examples because they provide a great way to stress-test a business model.
“Every best-case plan is based on multiple assumptions,” he explains. “Stress-testing by running a worst-case scenario gives you a chance to find out which of the assumptions makes the biggest—or worst—impact on your business. Is it the price you charge? The number of website visitors? The cost of your raw materials? Something else entirely?” He advises running multiple scenarios to find out. “You need to know the answers—and your investors, bankers and customers will probably want to know, too!”
Scenario plans should be based on a spreadsheet model of your business, similar to an income statement but incorporating external factors or assumptions. You can formulate best, worst and most likely scenarios by changing the assumptions, but everything else in the model should remain identical.
“Remember, the best assumptions to change are those things that are not entirely under your control—how much it rains, the cost of oil, the foreign exchange rate, your [search engine] page rank, or the amount of money you raise,” he counsels.
While some industries are more dynamic than others, all are subject to changing external forces that can affect profitability. Restaurants need to watch the price of food, trucking companies the cost of fuel, high-tech businesses the cost of programmers.
“Nothing stays static for long, so you’d better keep your model up to date,” Worrell says. If your basic assumptions change by a factor of 100 percent in the course of a year, then you should update your plans, and your strategy, at least monthly.
"A good stress test will tell you which variables you have to watch most closely, and how much variation you can handle before it makes a real impact on your business,” he adds.
Find more articles from this series here.