If the pandemic has shown us anything, it’s that corporate scenario planning may need to account for events that executives may have never even dreamed about. While many may have planned for a variety of systemic shocks, how many had as an option a global pandemic shutting down workplaces, closing national borders, and throwing the economy immediately into a deep decline?
Going forward, the most strategic CFOs must be willing to challenge the assumptions being used in the forecast models that drive scenario planning, both for the current pandemic and for future crises. They may need to help lead their companies in planning for continued uncertainty, with scenarios that depend on medical responses to the virus as well as government responses to the economic impact.
In a recent EY survey of CEOs, CFOs, and other top executives, more than three-quarters of respondents indicated that the pandemic would affect their organizations’ medium–to–long-term strategy. While 37% of the survey responders indicated that they would need to make moderate adjustments, more than 10% noted that the pandemic could cause a fundamental change that will require moving to new sectors to succeed.
CFOs will play a key role in determining how various scenarios will impact revenue, the cost structure, the balance sheet, and liquidity. Three key areas can shape how companies prepare for and respond to the uncertain environment ahead.
It is difficult to forecast and plan for various scenarios without the right data. But typical metrics, such as revenue and foot traffic, are now less available or relevant for future planning. Businesses are just beginning to reopen (or shut down again) and some revenue has been propped up by government stimulus programs that may not continue. Other data does not necessarily have the same implication as it did in a normal economy. For example, low gasoline prices would normally correlate with increased restaurant traffic, but that relationship is no longer linear.
One consumer company we worked with reconsidered which data it needed to augment its typical syndicated sales data and other inputs to develop a more accurate, timely forecast. Among the inputs it chose were weather data, cell phone tower data, social media mentions of its products, and ZIP code–level unemployment data. The finance team then performed a regression analysis to see which metrics would show causation. The result was more accurate forecasts that are now updated in hours, rather than weeks.
The CFO can take the lead in determining which inputs are most relevant and predictive for the business, with the finance team performing a regression analysis to see which metrics show correlation and determine which represent actual causation.
Once the CFO has identified relevant data inputs, the inputs can be run through various forecasting models, including decision trees and Monte Carlo simulations, to determine how changes in the data under different scenarios will affect the business.
This process can incorporate information from different functions across the business, but there may be a need for the CFO to be empowered to challenge the assumptions going into the models.
This flexible, dynamic scenario–planning can not only focus on the company’s own business, but it can also stress–test suppliers and customers to see how they will be impacted by, for example, a reclosing of certain borders or a rise in COVID-19 cases in key manufacturing centers.
It is essential to build “black swan” events into scenario planning, as we have seen that these events may not be as rare as executives assume. In recent years, massive fires on an entire continent, a pandemic, and geopolitical shocks all have affected business. Scenario planning not only identifies likely impacts on the P&L, balance sheet, and liquidity, it also helps companies identify market opportunities.
In one case, we have seen how the pandemic forced a change in how some consumer products, such as beer, are packaged. Bar owners learned that kegs caused too much inventory risk, and some news media reports chronicled how shuttered bars got stuck with stale beer during the lockdowns. There has been more of a focus on single-serving containers since and even some anecdotal evidence of an aluminum can shortage. That type of shift could impact how companies invest in their product mix in the future, which, in turn, could affect their entire supply chain.
Proper scenario planning can help companies gain better transparency into the risks they face in different situations. The CFO can then use the various scenarios to help guide decisions around the company’s cost structure, working capital policies, dividend policy, backup sources of liquidity, and other near-term measures.
Planning for the true worst-case scenarios can also help guide whether long-term investment needs to be made into a more flexible supply chain, different manufacturing facilities in different geographies, or other measures. For example, if a company forecasts that a key supplier might fail in X% of scenarios, the company could increase inventory levels while it finds more suppliers—or could even acquire the key supplier.
One lasting project the CFO can lead is to use information and lessons learned from the current crisis to develop a crisis playbook. This playbook may include specific actions to take in response to specific shocks to the business. These can be demand shocks, supply shocks, or both, and may impact specific geographies or the entire ecosystem. For example, an X% drop in sales may trigger a drawdown of funds under a line of credit, whereas a 2x decline in sales may further trigger the suspension of a dividend and the furlough of certain workers. The crisis playbook can also clearly define the crisis response team and its roles and responsibilities, as preparedness is the key to a quick response.
By improving forecasting and scenario–planning now, and preparing a plan for the next crisis, CFOs can help improve their company’s resilience, position it to weather market disruptions, and take advantage of the opportunities that come with any crisis.
Jim Hsu is global EY-Parthenon Strategy leader and Loren Garruto is EY’s global and Americas corporate finance leader. The views reflected in this article are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.