What-If A New Black Swan Event Happens Next Year?
and then there was Brexit, followed by Trade War, and now COVID-19. What will be next? We almost do not dare to think about what comes next but somehow something always comes next. That is also why the likes of McKinsey has labeled our current situation as the Next Normal. We must prepare ourselves for a series of unprecedented events that will keep hitting us year of year. We should stop waiting for normal to settle in but simply expect the next normal.
What does this mean for FP&A? It means that we must be prepared for most things. Our models should account for a black swan event each year. It is bound to happen somewhere in the world. It might not impact your company or region. It could even have a positive impact on your company. However, you must be prepared for this to happen. The alternative could mean the bankruptcy of your company and should in most cases be completely unnecessary.
Senior leaders in your company expect FP&A to take control of the situation and guide them safely through whatever crisis will hit them. However, if all you have is a budget and an inflexible forecasting model you will easily be challenged. That means we must increase our preparedness for what could hit and our ability to act when something does hit.
What-if modeling is the next normal of FP&A
In simple terms, we must ask the question of “what-if” a lot more and model scenarios around it. We should get used to the things that we do not know will hit us. If we know something will hit us with a certain likelihood it is easy to plan for. However, the whole point about black swan events is that they hit us unexpectedly and have a potentially big impact on our business. Therefore, we need to know how our business will handle such shocks and build action plans around it. Ask yourself questions like…
- What if prices change with +/- 50%?
- What if demand for your products changes +/- 50%?
- What if raw materials prices change +/- 50%?
- What if consumer trends shift rapidly?
- What if your company gets hit by reputational damage?
You might think some are easy to model whereas others might take some more work. However, most of them will take quite some work to model if you lack a strong financial model. Ideally, you should be able to change one input cell and directly see the impact on your bottom-line, but can you?
Realtime simulation is needed for faster decision-making
Even if you are only trying to simulate something that could happen in 6-12 months’ time it is imperative that you can show the potential impact on-the-spot. If you are forced to go out of the meeting to run some simulations, it could be weeks or even months before you get a good chance to discuss the impact again. Therefore, you should build a financial model where you can model the impact of the different what-if cases as you discuss them.
This is key because you can then qualify immediately which scenarios could have the largest impact on your business. This helps you determine where to spend your time and effort to develop action plans first. There is no point in giving equal importance to all scenarios if their impact and probability are not the same. Typically, the probability is a high-level assessment but the impact need not be.
How are you doing what-if simulations in your company? Can you do them on the spot or does it require days of work to get to any reasonable result? Your ability to do these simulations will affect your ability to influence decisions. Hence, this is a key enabler of being a business partner and driving the right strategic choices in your company.
This blog is presented by ValQ in collaboration with Anders Liu-Lindberg, Business Partnering Institute.
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