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Part of being an agile company is anticipating market forces before they happen and having a plan in place to dodge potential pitfalls while taking advantage of new opportunities.
To do this, you need to use financial forecasting and scenario planning.
Financial forecasting provides insights into how your company’s revenue and expenses are changing over time and will change into the future.
Scenario planning involves mapping out different possible futures over the short and long term, as well as how you will react to them.
Together, they give you the information you need to excel at strategic management.
What is financial forecasting?
Financial forecasting is all about taking the current trends of your company and projecting them into the future. This provides you the best guess as to how your company will do over the following one or several years.
Sound financial forecasts can predict how your revenue will change over time, and what those changes mean for your expenses.
For example, if you project that your Monthly Recurring Revenue (MRR) will increase by 10x in the new year, what would that mean for your labor needs? Do you have a hiring plan in place to accomplish that?
Financial forecasting generally starts with forecasting how your sales will change month to month over the following year. This is usually supported by defining your marketing plan and how that will translate to visitors and leads.
Then, you need to consider how your labor and other expenses will change with increased sales and a larger user base. A great budget template can help with this.
What is scenario planning?
The essence of scenario planning is building assumptions about how your business and market niche are going to change in the future. Since the future is uncertain, you want to create several sets of assumptions and plan accordingly.
Once you have identified different sets of assumptions, you then consider what you can do when those different scenarios occur.
It isn’t enough to just see the different scenarios that might occur. You need to have plans in place to react to those different scenarios and steer them towards your ideal one.
Scenario planning is an incredibly powerful tool used by governments, militaries, and businesses alike to prepare for contingencies. You can bet your competition is using scenario planning and so should you!
How do you perform scenario planning?
Now that you understand why scenario planning is important, I am going to run down an eight-step process to perform scenario planning in your SaaS enterprise.
A full, detailed scenario planning session can last several months and entail the consumption of significant financial resources.
While that is a worthwhile venture for larger companies or the government, it might be beyond the resources of a bootstrapped startup.
However, you can still get great value from having your management spend a couple days working on a decent scenario planning exercise and then reviewing it every quarter. Below are steps that companies of all sizes can take to start scenario planning.
Step 1. Find your focal issue
You can’t model everything. Not only would it take over a year to model every contingency during a year, most of those possibilities are inconsequential anyways.
It is also true that you only have so much bandwidth to plan and react to changes. If you do not have the resources to react to a change, then it shouldn’t be a focal point. Consider working from a single “what would happen if” question:
What would happen if a new competitor entered the market?
What would happen if our growth stalled?
What would happen if Google changed its algorithm?
What would happen if a celebrity tweeted out our company and the user base grew astronomically in a couple days?
Step 2. Define the key factors
This is the “no bad answer” brainstorming part. Take your “what would happen if” and map out every factor that would affect that scenario.
These can be the factors that would make it more likely to occur, make it worse or better for you, or what would happen as a result.
Then, cut down the list to the major factors that would affect the conditions of the scenario and your ability to deal with it.
Step 3. Identify the external factors
Your company doesn’t operate in a vacuum. There are other businesses in the market niche. There are you customers and prospects. There are all the tools you need to use. There are also governments involved.
While you might not think your tiny company is vulnerable to the whims of governments, that’s not the case. For example, General Data Protection Regulation (GDPR) in Europe drastically changed how websites and apps can store and use data. Do you have plans in place in case a similar law were enacted in America?
Step 4. List all critical unknowns
Steps 2 and 3 call for listing everything. In those steps, it is better to get a chuckle for a silly factor than miss one of importance.
Here you need to be a bit more selective.
For example, with inflation rising, it is only a matter of time before central banks start raising interest rates. In that case, “what will we be paying on our business loan” is a critical unknown, while “is the banking sector going to collapse” is not as useful.
Consider having your team vote on the issues raised based on two factors: their importance and how hard it is to predict them.
You want to know all the important factors that you cannot predict easily.
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Step 5. Plan out the scenario logic
Now that you have a good idea of the critical uncertainties to your business, it is time to set up a logical set of scenarios.
While a company with an infinite budget with a huge workforce might be willing to map out hundreds of scenarios, you are going to want to focus on between two and five.
The US military has the resources to contemplate an alien invasion, but you don’t. So now you are going to consider the truly important factors to your business and the realistic values of uncertainty.
Let’s say you think the likely range of your MRR growth is between 50% and 200% in the next year. You also think that your payroll expenses will increase between 5% and 20% over the next year.
Then, you can build a 2×2 matrix with MRR growth on one axis and payroll expenses on the other:
MRR growth = 50%
MRR growth = 200%
Payroll expense increases 5%
Payroll expense increases 20%
Step 6: Create your scenarios
Now you want to build a narrative of how you get to these scenarios and what that means for your company.
If your payroll expense growth outpaces MRR growth, is that because you over-hired or because you were previously underpaying for key roles?
If your MRR growth exceeds your payroll expense increase, is that because you have found efficiencies or because you are now providing poor customer service and there is a disaster waiting to happen?
This stage is all about storytelling. You want to build a realistic and detailed story about how you could get to each scenario.
Step 7. Figure out all the implications and options
After Step 6, take a break. It requires a couple weeks or months for the team to regain their objectivity about the scenarios. For example, do the first half of scenario planning in the summer and then incorporate the second half into your year-end planning meetings.
When you come back with fresh eyes, it is time to understand the implications and options.
Implications are what it means for your company if Scenario 2 vs. Scenario 1 occurs.
Options are what you can do in Scenario 1 vs. Scenario 3. You should also come up with options for how you can move from Scenario 3 to Scenario 4.
Step 8. Define early indicators
How would you know in January or April that your end-of-year Scenario 2 is happening instead of Scenario 4?
Early indicators are signals in your metrics that things are progressing towards a specific scenario.
If March and April tend to be where you get 60% of the new users per year, then by the middle of March you should be reacting to the MRR growth you are seeing to push towards the rosier scenarios.
By the end of April, you should have a good idea of whether MRR is growing by closer to 50% or 200% this year.
Similarly, if your recruiters are finding it hard to get new quality team members at the salaries you are offering in June, then that might be an indication payroll expenses are heading towards a 20% increase.
Scenario planning and financial forecasting are related strategic tools. They help you predict and therefore plan for the future.
Once you appreciate the uncertainty of the years ahead, you can begin to build plans to work towards your ideal future.
That’s why growing SaaS companies use Forecast+ by Baremetrics. To start modeling your finances and effectively operate your business, import your bookkeeping and accounting into Forecast+ today.