Scenarios Address Economic Uncertainty

CUNA’s E-Scan
July 18, 2011 | COMMENTS

Recessions and the recoveries that follow provide many of the best opportunities to secure market share and get new projects off the ground.  CFOs can play a critical role in those efforts, according to John Stewart, managing director at consulting firm Vantage Economics (vantageeconomics.com).

Most financial experts understand that the economy has an impact on their business. That's the easy part. But problems arise when trying to measure that impact on projects or operations, and in developing long-term strategies in an environment focused on immediate issues and mitigating risk.

The key is to get to the heart of why the economy is changing, says Stewart, which will enable financial executives to identify the real challenges to an individual company or a specific project.

Rather than worrying about what the government should do, executives should look at how different scenarios might impact their own company's projects and investments.

For example, when the economy goes into recession, interest rates will fall and stay at relatively low levels well after it ends. This rule, and others like it, will create both opportunities (low interest rates) and risks (further recession).

To understand the opportunities and risks, Stewart, writing in Financial Executive magazine, suggests executives follow three principles: be specific, be prepared, and understand how to take advantage of current conditions.

Be Specific

In attempting to understand the overall impact the economy has on a company, many in finance simply compile data on items such as employment and interest rates.

But without identifying specific environmental and economic changes, financial executives will not be able to overcome the looming challenges.

Consider the recent transition of the consumer, advises Stewart.

The U.S. economy has been hit hard because of significant cuts in personal consumption. Along with this has come higher demand for value-added services, trust, and transparency. It’s critical to understand how a company's core products and future investments relate to consumers who are risk averse and seek value.

Be Prepared

Even in a flat economy, Stewart argues “that doesn't mean simply sitting on one's hands and doing nothing.” Now, even more time should be spent developing multiple strategies.

Building planning scenarios concerning revenues and costs can be beneficial. Not to be confused with the current practice of frequently reforecasting, building scenarios means generating several possible forecasts, based on various economic conditions, all with a decent likelihood they could come to pass.

It’s good policy, says Stewart, to generate three forecasts—high, mid-level, and low estimates—aimed at both improving accuracy and helping to paint a picture of risk.

And it’s assessing risk that provides the most benefit of a forecast, Stewart claims. Instead of arguing about the forecast, the management team can create a baseline plan and then discuss the critical decisions necessary in a low-range or high-range scenario.

Understand Change

Not surprisingly, economic conditions are fluid. The economy thus far has come out of the recession with only modestly improved business activity, insignificant job growth, and serious questions about the sustainability of the recovery.

Nonetheless, even these circumstances can empower financial executives to create strategies as information becomes available and to implement them immediately when the need for action arrives.

In fact, this epitomizes the idea of being proactive rather than reactive, says Stewart.

Many economic forecasts suggest the probability of slipping into a second recessionary cycle is small. This shifts the paradigm of risk to one that allows CFOs to be slightly more accommodating to risk.

However, since the near term is likely to behave much like it has of late, the likelihood of a return to pre-recession growth before year's end is slight. There’s a risk that even modest growth may not continue throughout the year.

Overall, economic change has a real impact on a CFO's strategic decisions. Thinking about how to manage finances through those changes can help managers recognize both opportunities and risks. In doing so, they can place the company in a much better position for the future.