What is Scenario Planning and Why Your Business Needs it
Did you know that the average business faces 12 major disruptions each year? Whether it’s an employee unexpectedly leaving, competition popping up, changes in consumer behavior or economic disruption, small business owners face constant pressure to pivot and get out in front of change.
Many small businesses that fail do so because they can’t handle this kind of uncertainty. But even when faced with constant change and unpredictability, savvy owners don’t just cross their fingers and hope for the best.
The answer to uncertainty? Scenario planning.
What is scenario planning?
Scenario planning is really just a formal way of saying that a business owner is going to map out multiple financial outlooks for their business. It’s about considering the possible impacts of “what-if” scenarios on their business, like:
- What will the impact on sales be if tariffs raise inventory costs by 10 percent?
- How long will it take for a new product or service offering to become profitable?
- How will increasing (or decreasing) employee headcount affect business expenses?
Think of scenario planning as creating multiple contingency plans. The upfront work means business owners can feel prepared instead of panicked when circumstances change, and have smart responses mapped out in advance.
Scenario planning versus financial forecasting
Financial forecasting is crucial for small businesses. Forecasts are financial projections of future revenues, expenses, cash flows and other metrics, based on past performance or educated guesses. That last point — educated guesses — is important, because there’s no such thing as a perfect forecast. No one really knows what’s going to happen in their business until it happens. Forecasting is a business owner’s best effort to plan for the most likely future outcome (and it’s revised as time passes to account for what’s actually happened).
Scenario planning builds on financial forecasting. How? It takes a forecast, and then explores multiple outcomes depending on what might happen.
Think about it like being on a road trip. A forecast tells a driver where they’ll likely end up if the road stays straight. But scenario planning helps them map out roadblocks and detours, to increase the chances the driver reaches their destination on time.
Scenario planning in action
Let’s show an actual example of what scenario planning looks like in action, using LivePlan (you can watch me play out this scenario in the video above). This scenario involves a coffee shop dealing with a sudden increase in the cost of coffee beans.
The picture above shows this coffee shop’s profit and loss forecast for three years. As you can see, the owner of this shop is projecting $19,740 in profits in year one, for an 8% profit margin.
Now let’s zoom in and look at some of this coffee shop’s expenses. The picture below shows the direct costs for making espresso drinks. This forecast indicates that each espresso the shop makes costs it $3.
But what if things change? After all, the economy in 2025 is extremely volatile, with tariffs threatening to drive up the cost of imported goods — like coffee beans.
So, let’s say that those beans suddenly become more expensive. Now, the espresso that used to cost $3 to make costs $5.
See the difference in the previous two images? The shop’s monthly expenses for espresso drinks more than doubled.
Remember that the shop was forecasting a bit under $20,000 in profit for 2025? Let’s see what impact these higher costs have on its bottom line.
Yikes. That projected profit has been completely erased, and now the coffee shop is projecting a $3,241 loss for the year.
Of course, this is just a scenario plan based on a small business making assumptions about what’s going to happen in the future. But here’s why scenario planning is so powerful. If this were a real business, the owner would have valuable data to help them make decisions. In this case, they could go back into their scenario and raise their espresso prices to a level that brings them back to profitability.
The original forecast put the price of espresso drinks at $6.50. Take a look at what happens when the price increases to $8.
Back to profitability! Not as profitable as before the bean prices went up, but certainly better than when it just absorbed the entire cost increase without passing some of it on through higher espresso prices.
If the owner of this shop wanted to refine their forecast even further, they might create a scenario plan where espresso drink demand falls a bit due to the price increase.
But for the purpose of this explanation, the point is that taking time to create a scenario plan helps small business owners understand how to respond to a wide range of possible situations.
A coffee shop owner can’t control if their imported beans become more expensive. But a scenario plan will put them in a much better position to anticipate what might happen and map out the best response for the long-term financial health of their business.
And this situation can be applied to any type of small business, whether it sells products like coffee, or services like massage therapy, dog grooming or accounting.
Start scenario planning today
If you want to get better at scenario planning, a good place to start is with our free income statement template. Download it now and start plugging in numbers to see how different scenarios could affect your business. You can also try LivePlan for as little as $20 per month to easily build up to 10 scenarios with revenue and expense streams specific to your business.
Sabrina Parsons
Sabrina has served as CEO of Palo Alto Software since 2007. She and her husband, Noah, founded a UK software distribution company in 2001 that was acquired by Palo Alto Software in 2002. Sabrina is a successful Internet expert, having served as Director of Online Marketing at Commtouch, Senior Producer at Epinions, and founder of her own Web consulting company, Lighting Out.
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