Three ways scenario planning improves your accountancy firm’s partners’ margins
Profitable accounting and financial planning demand effectively defining and timing future resource deployments. FP&A scenario planning helps you do this by showing you what’s on the other side of uncertainty and letting you see what different decisions will look like without the risk.
Why scenario planning matters for streamlined accounting processes?
Despite our best attempts, our forecasts will have inherent errors, with actual results deviating from the figures we had anticipated hitting. Rather than marry your plans to one set of forecast figures, you may want to employ a varied approach, contemplating optimistic and low-cases and assigning probabilities to each. With this approach, you remain more forward-thinking and agile as circumstances change, which can help you adapt the margins your partners expect as circumstances change. But how?
Rather than simply crafting possible scenarios, wouldn’t it be better to simulate how changing assumptions and drivers may impact specific margins? This lets you almost create a future reality before it occurs. While planning for scenarios is wise, as it enables you to contemplate how the direction of your business may change, precise tracking is still essential.
Because when you know how you are faring, you can pivot and refresh your scenarios versus expectations. In fact, the most capable accountancy firms can recalibrate their ERP for accounting scenario planning in real-time when circumstances trigger a change—giving them the ability to optimize their partner margins more efficiently.
Here are three ways you can use scenario planning to boost partner margins:
1. Toggle between scenario and plan instantly
The essence of scenario planning is consistent whether considering profitable accounting, enterprise planning, or even personal financial planning. In the context of personal finance, many of us may employ scenario planning to estimate our future retirement balance. Rather than sensitize just one input, such as the average annual rate of return, scenario planning allows us to manage the forecast across all key elements.
For instance, we may designate an aggressive scenario with an average annual rate of return of 16%, a standard deviation of 0.21, an annual investment of $30,000, and a years-to-retirement of 30 years. Alternatively, we may designate a conservative scenario with an average annual rate of return of 8%, a standard deviation of 0.10, an annual investment of $35,000, and a years-to-retirement of 35 years.
And this is no different for accountancy firms. You need to quickly toggle between your different scenarios and your actual position to plan accordingly for the future and do so instantly. As a personal or business investor, if you determine that a conservative case is our preferred investment strategy to achieve our objectives, we operate in line with those parameters. As time progresses and our reality changes, you can develop new scenarios that guide you accordingly. All working on letting you identify the opportunities for greater growth, the risks involved and how to mitigate them.
2. Analyze capital expenditures
Another excellent use for scenario planning is in the analysis of capital expenditures. CAPEX forecasting is notoriously tricky, as it contemplates how near-term investment in assets will translate into unrealized long-term benefits.
Scenario planning lets you assess not just how you will plan potential projects but how they will affect financial metrics such as liquidity and return on assets or margins. Create various forecasts that allow you to compare ‘what-if’ scenarios. These help you visualize the potential result before investing large sums.
For example, you may consider developing and maintaining an ERP system costing $1.75 million and annual incremental expenses for hiring, marketing, customer service, and other admin. These expenses, depending on the scenario contemplated, range in total from $223,000 to $556,000. Incremental gross profit, depending on the scenario considered, ranges from $302,000 to $688,000. Your decision to invest in the ERP system is justified mainly by which scenario you believe is most realistic.
3. Trial different accounting pathways
Like sensitivity analysis, scenario planning lets you consider probabilities assigned to different pathways. If you contemplate three scenarios in the above ERP business case – best-case, base-case, and worst-case – you also should conduct diligence to determine which of these cases is most and least likely and to what extent.
For example, if you find the best-case to be 50% probable, the base-case to be 30% probable, and the worst-case to be 20% probable, you can reach an outcome heavily weighted toward the upside. Knowing these scenario probabilities lets you plan with a heightened degree of confidence in your forecast and, ultimately, your decisions. Like sensitivity analysis, you should consider how you can more effectively manage risk across the scenario by focusing on your critical individual drivers.
Make sure your ERP accounting system can scenario plan
An accountancy firm making decisions without scenario planning is tying itself to a limited number of assumptions and exposing itself to unnecessary risk. While those using scenarios in their planning can move quickly without the risk.
Public and PE-funded companies, in particular, should be wary of the pressures of earnings expectations, which often require the company to back into targeted figures rather than arrive at them through the development of possible scenarios. Despite external pressures, firms should identify earnings estimates as just one of the many outputs and objectives that scenario planning can help them reach.
Finally, an unforeseen but welcome benefit of this technique is as you grow more confident in your scenario forecasting, you will also increase your ability to reduce planning cycles. That’s something to look out for.
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