Years ago, small businesses would source products locally. Even though they may be able to purchase a product at a lower cost overseas, the cost of shipping and importing these products was very expensive. This meant that disruptions in getting products to market were relatively predictable. The suppliers, the sellers and buyers for the products were all local so there were subjected to the same economic and environmental conditions.

In a global economy, the cost of importing goods has decreased dramatically and businesses now source products from many parts of the world. With this freedom to source from many areas of the world comes a new set of issues to the business owner. Volatile currency exchange rates along with disruptions in the supply chain from earthquakes, fires, flooding and political instability in Asia or Europe can potentially destroy a local business overnight. Most companies do not plan for these issues until it is too late. Desperately working to find new suppliers for goods that you have already received orders for can start a negative business spiral that increases expenses, reduces margins and creates bad customer relations.

Successful companies now realize that they must reduce this risk to their business by developing contingency plans before a crisis occurs. To develop these plans they use a process called Scenario Planning. Scenario planning allows a business to investigate and create alternative plans to ensure their business is secured against disruptions from external forces outside of their control.

In this article we will review the steps to effective scenario planning.

Step 1 in scenario planning is to define the objective.

In our business example we are going to look in detail at our theoretical companies supply chain. Our business has 20% of the product line representing 80% of the bottom line profit. We find that 90% of the profitable product line comes from Asia and Europe. Typically our lead times from these suppliers are 4 weeks. We keep a small inventory for emergencies in Canada. So we have identified that we rely heavily on the supply chain to keep inventory low and to meet customer service levels.

Based on this information we decide that our objective is to review possible scenarios that adversely affect our supply chain. In each scenario we will review how the business metrics of cash flow, inventory, cost of sales and lead times are affected. We decide to select team members involved with the supply chain, including purchasing, inventory, manufacturing (if there is any component done here) and shipping.

Step 2 is to define key drivers that affect the supply chain scenarios. In this case we would look at the product suppliers and the logistic companies involved in delivering the goods to our location.

Step 3 is to collect data. We contact the suppliers and logistic companies to ask for their scenario plans. Do they rely on one plant to manufacturer the goods? How many "down days" do they have each year over the last 5 years? What if a labor strike or a natural disaster were to hit their plant, what is their plan to minimize product supply delays? What plans does the shipper have if a typhoon or a weather issue closes their main hub?

Step 4 is to create the scenarios that are based on the data collected. Is there is a time of year risk to any parts of the supply chain due to weather? What happens if political tensions or natural disasters affect the country where the main plant for the manufacturer is located? These scenarios need to be tested to see their affect on cash flow, the ability to meet orders, inventory levels as defined in step 1.

Step 5 is to present the scenarios to management and decide which ones have the greatest risk to the business. We then create strategies and contingency plans, such as increasing inventory during known times of bad weather in the region of the supplier, or investigate using other suppliers or logistics companies from different regions. Perhaps the logistic company can inventory a defined number of high moving profitable products as a contingency plan.

Finally these plans must be revisited on a regular basis to be updated based on changes with suppliers and logistic companies and company objectives.

In a world wide economy, a snow storm in Europe or a flash flood in Asia could have an adverse affect on your cash flow and business growth.

Today's fast paced, fiercely competitive business environment leaves little margin for error or indecision. A consulting CMA, such as Numbers Plus's own Mark Stebbing, brings you a seasoned professional equipped with years of specialized training and business experience. Mark is trained to provide solid strategic advice, sound business management and decisive leadership and of course sound accounting and tax advice.