Imagine someone taps you on the shoulder, but you can’t see him or it. An authoritative voice you believe says there will be 7 years of prosperity in your business followed by 7 lean years of declining sales. What’s your next move? Calling your therapist is not an option.
Some of my favorite business stories are recorded in the Old Testament. The one above is based on a dream that the biblical Joseph interpreted for the Pharaoh of Egypt. Joseph correctly interpreted that there would be 7 years of plenty followed by 7 years of famine.
I’ve heard a few economists say that Joseph’s follow-up suggestions to Pharaoh were the origins of the first income tax. I’m not sure of that, and it’s beside the point.
Joseph recommended that Egypt collect one-fifth of each person’s harvest in order to be stored and sold during the famine. Stroke of genius. Or perhaps the person who tapped Joseph on the shoulder was
Do Forecasts Have to be Accurate?
For those of us living in Missouri, one has to be careful when listening to the weatherperson telling us how to prepare for the next 3 days. That’s especially true during the winter months when snow and icy conditions are difficult to forecast. My non-scientific calculations have their predictions on snowfall amounts at about 50 percent.
Is that level of accuracy adequate? In my case it is. It means I’m prepared. In January when the temperatures were frigid, we were without electricity for nearly a full day on a Saturday when everyone was home. We were prepared.
A few weeks later, another major storm was predicted. We were prepared. The storm fizzled. So we had a lot of excess food and water in our pantries. No big deal.
As financial leaders, do we need to be experts at forecasting the future? Can we wing it? Or do we turn our forecasting requirements over to a data scientist who is an expert in predictive analytics?
My Approach to Forecasting
I became an Excel junkie in the early 1990s. I ultimately started playing around with a tool called Evolver which was Monte Carlo simulations on Barry Bonds steroids.
I found myself
And that leads me to scenario planning. I hit the jackpot at an annual Quantrix seminar when I got to sit next to Dan Murray, one of the coolest guys on the planet in the visual analytics domain space.
Dan stated one of the most influential books he’s read has been The Art of the Long View: Planning for the Future in an Uncertain World by Peter Schwartz.
As stated in the Introduction, the premise of the book is showing business leaders how to make strategic decisions for all plausible futures. Regarding the use of scenario planning:
Scenarios are thus the most powerful vehicles I know for challenging our “mental models” about theSchwartz, Peter. The Art of the Long View. The Crown Publishing Group. Kindle Edition.
world,and lifting the “blinders” that limit our creativity and resourcefulness.
There are plenty of critics of the Schwartz book. A prevailing theme is that it’s dated with anecdotal evidence. That’s missing the point. Scenario planning is not a rule, it’s a mindset or a go-to mental model in the right situations.
You don’t need to slow-read it word for word. Do a fast read first. Re-read the parts you find relevant in your business situation.
My biggest takeaway is that I no longer use best, likely, and worst-case scenarios in my models. I now give my scenarios names where I get as specific as possible for numerous conditions that could happen in the future.
Another Must-Read on Forecasting
If I could only pick one book on forecasting for business leaders, I’d recommend Future Ready by Steve Player and Dr. Steve Morlidge. My favorite part of the book is what they don’t teach you. The authors don’t drag us into complex, scientific algorithms throughout the book.
Future Ready reminds me of a college textbook as the research for this writing is nothing short of remarkable. You don’t fly through this book which emphasizes the meaning, process, and inherent risks of forecasting. This is a slow-read book that you need to study, put down, and pick up again over the course of a week or two.
My favorite highlight from the book is:
Debating ‘what is the right number’ is a waste of management time. Instead the focus should be on ‘what is the range of possible outcomes’.
The above excerpt is from a quote in the 2008 McKinsey Quarterly where they assert even in normal times that the range of forecasted outcomes most companies consider is too narrow. Morlidge and Player follow up this discussion on the importance of scenario planning, the topic addressed earlier in this post.
Future Ready is heavy on historical context, theory, mindset, and insights as it relates to forecasting. Don’t get it if you’re trying to learn a new Excel technique. This is a book for leaders. Practitioners can learn from it. Just don’t be disappointed if you are looking for the 6-step process to building a better forecast.
Dr. Morlidge has also written a companion book called The Little (Illustrated) Book of Operational Forecasting. Little – no kidding. I wish the book was bigger in physical size, but I suppose I’m giving away my age.
Get it. Read it at lunch when you are by yourself. Read it when you are waiting for a call or a meeting in your office. It’s a nice reference book.
A Forecasting Bonus Book Selection
For six-plus years, I was a board member of the credit union I’ve been using since 1991. I appreciated our CFO who ultimately became the credit union’s President. She was the first person to expose me to stress testing. As a student of corporate finance, that was not a term tossed around in business journals or periodic CPE classes I attended on financial
Stress testing as taught to me by this CFO was a form of scenario planning. While the focus was on scores of what-if outcomes, the relevant question became, “What happens if x happens?” As Bruce Reed, one of my favorite CFOs would put it so eloquently, “What happens when bleep hits the fan.” Sorry for bleeping you Bruce, this is a family-run site.
When I first learned about the book Stress Test in 2014 by Timothy Geithner, I got it immediately. Thanks to that book, stress testing is on my brain at all times when I’m doing business forecasting of any kind.
The book is long, but it’s still gripping. If you work in FP&A or if you have a financial leadership position, read or listen to it. Betty (of United Credit Union), your words were spot on
A Final Bonus Pick
Last one. I promise.
I read my fair share of FP&A literature, and this (cool) guy is never mentioned. His name is David Goldsmith, and he’s the author of Paid to Think, a book that I binged-read in 2013.
The chapter I want to call attention to is Forecasting the Future (chapter 14). I’ve never asked the author about his intended audience for the book (he actually called me from the Asian Pacific Rim one morning while I was driving in Fayette, MO after I gave him a high five on Twitter).
My hunch is that David’s audience is the CEO, business leader, or a president running a division of a larger organization. If that’s true, his section on forecasting is still exceptional for members of the FP&A community and other financial leaders.
Some of David’s key concepts on forecasting include:
- retro, current, and forward leadership thinking
- the link between forward-oriented forecasting and desired outcomes
- activity-based forecasting
- the 5 areas framework of potential forecasted opportunities and challenges
- 4D forecasting vs 3D forecasting
I like David’s writing because it’s accessible. He’s framework oriented. His content is right-now actionable, but you’ll still need to fill in some of your own blanks. Great read. Get it.
Can God Forecast?
I never did answer the question, and I will not. I’ll leave that up to you.
Here’s what I like about that ancient, Hebrew story told earlier. God never told Joseph directly what to do. Through another person’s dream, Joseph learned what the future would look like. He had to go figure out what to do next. Hardship still followed during those 7 years of famine. But the outcomes were not as bad had that
Therein lies the key to forecasting. Planning. Re-planning. More re-planning. Wash, rinse, repeat. The goal of forecasting is not about a perfect number. It’s about being prepared for all possible outcomes. Are you?