What Is a Base Scenario?
A base scenario refers to a set of basic assumptions that are expected to result in the most realistic outcome of a series of events. It allows an analyst to construct variant scenarios by changing key variables to determine the deviation between the variant outcome and the base scenario outcome. This type of scenario development process is a decision-making tool that is used in business planning, market forecasting and in other types of situations where a major strategic decision must be made.
In business, it is virtually impossible to know for sure what will happen in the future. Executives must make decisions based on the information they have in hand and their professional opinions about what is most likely to happen in the future. The process of deciding on course of action that will have a future outcome involves input from various people that must be weighed and synthesized to determine the course that will meet with the most success.
Input that goes into a decision-making process involves estimates and assumptions. If a decision about production levels today depends on the future price of oil, for example, the only way to include that information in the analysis is to look at the historical price of oil and make an estimate about future prices based on certain market assumptions. There is no reliable way to know for sure how much oil will cost in 24 months, so any production changes a business makes now that are based on that variable have a degree of risk.
Executives use base scenario planning to work through the possible outcomes from changes in key variables. The base scenario is what the analyst feels is the most likely outcome, based on history and knowledge; this includes estimates and assumptions, but those inputs are added to the scenario at their most likely levels. Once the base scenario is established, analysts construct variant scenarios that explore possible outcomes if key variables change.
This type of analysis enables business executives to prepare for best- and worst-case scenarios. No business wants to be caught flatfooted if the market changes suddenly or a critical input becomes unavailable from a regular supplier. Scenario planning keeps businesses flexible. This type of decision-making process allows executives to create backup plans, so the company knows what to do if things change.
One of the most common uses of base scenario planning is when new business owners create a business plan to seek startup funding. Investors typically expect the owner to present financial statements that reflect the most likely financial scenario for the business in its first few years and to present worst-case and best-case scenarios that reflect changes to the owner's basic assumptions. These investors typically want to know that the owner has a plan in place if something substantial changes.
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