Former Federal Reserve chairman Alan Greenspan made plenty of news in October when he admitted before Congress that he had “found a flaw” in his model of financial reality, but another, less-publicized portion of his testimony should resonate with CFOs. The Fed’s failure to anticipate the risks and consequences of securitizing and selling mortgages, Greenspan said, was due to poor forecasting.
“We’re not smart enough as people,” he said. “We just cannot see events that far in advance. There are always a lot of people raising issues, and half the time they’re wrong.”
Few if any CFOs have the luxury of throwing up their hands and citing human limitations as an excuse for their inability to foresee adversity. Indeed, uttering such words in public would immediately erode any confidence that a board and investors had in a finance chief. Suggest that you agree with Greenspan that forecasts often have no better than a 50-50 chance of being right and the impact on your career may be all too predictable.
And yet Greenspan may be right. For example, in a recent lawsuit filed by chemical maker Huntsman to force a merger with Hexion, Hexion’s CEO testified in open court that forecasting raw-materials costs is almost impossible. According to documents supplied by Huntsman in a Securities and Exchange Commission filing, Hexion’s method of forecasting raw-materials costs is to arbitrarily prognosticate that they will remain flat, pretty much ensuring the numbers will be wrong. (Hexion declined to comment, due to litigation.)
Meanwhile, forecasts of 2008 revenues and profits have missed the mark substantially at many organizations. That’s not remarkable, given that the speed and severity of the third-quarter collapse caught nearly everyone off guard. What is surprising is the degree to which forecasting, a task that few companies have ever felt very confident about, is now so difficult that in a spot survey of 250 Website visitors (see “The Dark Side” at the end of this article), CFO found that 70 percent say they can’t forecast more than one quarter out. (Of those, one-quarter said they can’t forecast more than two weeks ahead and an equal number said “We’re in the dark.”)
But abandoning the prediction game is not an option. Companies are now redoubling their forecasting efforts, even though (and perhaps because) the horizon is brimming with unknowns. In a recent CFO Research survey, 41 percent of senior finance executives said they have strengthened scenario-planning procedures in light of the banking crisis. Retail organizations in particular are scrambling to manage inventory and adjust financial projections with the knowledge that holiday retail sales may decline for the first time in more than 10 years.
“Companies need to get the best perspective on what the future looks like so they can make actionable decisions and share information with investors and stakeholders,” says Stephen Lis, partner in charge of business-performance services at KPMG.
The credit crisis and the downturn in world economies may offer a useful lesson: forecasting can’t be just about number-crunching. Static spreadsheets filled with hundreds of line items that represent best guesses from operations just won’t cut it if a company hopes to produce forecasts that aid quicker, fact-based decisions under stress.