A base scenario is a set of basic assumptions that should lead to the most realistic outcome of a series of events. It enables an analyst to create variant scenarios by altering key variables and calculating the difference between the variant and base scenario outcomes. This type of scenario development process is a decision-making tool used in business planning, market forecasting, and other situations requiring a major strategic decision.
It is nearly impossible to predict what will happen in the future in business. Executives must make decisions based on the information available to them and their professional assessments of what is most likely to occur in the future. The process of deciding on a course of action that will have a future outcome requires input from a variety of people to be weighed and synthesized in order to determine the best course of action.
Estimates and assumptions are examples of input into a decision-making process. If a decision about production levels today is based on future oil prices, for example, the only way to include that information in the analysis is to look at historical oil prices and make a forecast based on market assumptions. Because there is no reliable way to predict how much oil will cost in 24 months, any production changes made now that are based on that variable are subject to risk.
Executives use base scenario planning to think about what might happen if key variables change. The base scenario is the analyst’s best guess at the most likely outcome based on past experience and knowledge; it includes estimates and assumptions, but only at their most likely levels. After the base scenario has been established, analysts create variant scenarios to investigate what might happen if key variables change.
Business executives can use this type of analysis to plan for the best and worst-case scenarios. No company wants to be caught off guard if the market shifts unexpectedly or a critical input becomes unavailable from a reliable source. Scenario planning allows businesses to be more adaptable. This type of decision-making process enables executives to develop contingency plans so that the company is prepared if things go wrong.
When new business owners create a business plan to seek startup funding, one of the most common uses of base scenario planning is when they create a business plan. Investors typically expect the owner to present financial statements that reflect the business’s most likely financial scenario in its early years, as well as worst-case and best-case scenarios that reflect changes in the owner’s basic assumptions. These investors usually want to know if the owner has a contingency plan in place in the event of a major change.