Dear Will

In this issue of Forecast, we're going to take a look at Scenario Analysis - how to take some of the mystery out of forecasting your business turnover and costs.

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With best wishes,

Graham

How to Use Scenario Analysis in Your Business

Scenario Analysis looks at how your revenues and costs can change. It is an essential tool for managing a business of any size, and you can use it to help draw up your sales forecast once a year. Armed with the information Scenario Analysis gives you, you can rapidly identify problems and opportunities - and do something about them.

A pitfall, especially for new businesses, is working out the level of sales you need for your business to be viable and putting this figure in as the forecast! To avoid the temptation, why not plan for more than one outcome? Set yourself a budget you will achieve and a target you would like to achieve. Don't be too ambitious with the budget - and go public on it, so your staff and advisers can help you achieve it.

Before You Begin

Here are a few questions that may help clarify your position:

• How many new customers do you gain each year?
• How many customers do you lose each year?
• What is the average level of sales you make to each customer?

For existing businesses, the starting point for your forecast may be last year's sales. If your business is new, you will have to make assumptions based on market research and good judgement. Every business can also add in the new customers that it expects to attract without knowing who they are, or what they will buy. Simply enter "new customer" in your analysis.

Depending on your type of business, you may want to forecast the volume of sales - for example, how many cans of paint you sell - as well as the value of sales. This helps you plan necessary resources in areas such as production, storage and transport.

Developing Your Forecast

Start your Scenario Analysis by writing down your sales assumptions. Creating your sales forecast becomes easy once you've found a way to break the forecast down into individual items. Can you estimate the conversion rate - the percentage chance of the sale happening - for each item?

For example, you might aim to have 10 clients each spending £10,000 to produce £100,000 turnover. At the start of the year, look at where things are:

If three customers have already signed a contract, your conversion rate will be 100%. If you can reasonably expect three repeat clients, give them a 75% probability - conversion rates for existing customers are much higher than those for new customers. Three clients who have had a proposal, but not signed yet, you might assign a 25% probability, and those potential clients you haven't even met yet, a 5-10% probability.

Now you can do the sums:

So £60,500 is your 'factored turnover'. The exercise tells you what you need to know: that you need 10 signed-up clients to meet your budget. If you need the £100,000 turnover, then you will need to increase the number of proposals you are writing. You also need to keep in mind the positive impact if your conversion rates turn out to be higher than you predicted - Scenario Analysis allows you to look at various potential outcomes.

Scenario Analysis and Your Costs

You can also work out how many £10K clients you need to break even, by doing Scenario Analysis on your business costs. For example, what happens if costs go up by 10%? How much do costs have to go up before your profit disappears? Effectively any line in your budget can be the subject of Scenario Analysis - for example, how will changes in fuel price impact your business; how much stock will you need to buy in to meet orders without leaving excess; or how many staff will you need to meet predicted demand?

Managing Your Business More Effectively

If you accurately forecast your sales and costs, you can avoid unforeseen cashflow problems and manage your production, staff and financing needs more effectively. By using Scenario Analysis to predict various possible outcomes, you can get closer to forecasting what will actually be sold, and what your business will actually cost to run. This is far more accurate than simply setting a target figure and then trying to work out how to achieve it!