The band Paramore is in the business of misery, cows are in the business of mooing, ghosts are in the business of spooking.
CFOs, meanwhile, are in the uncertainty business, or more specifically, the forecasting business. And in the tumultuous times we currently live in, that’s becoming an increasingly difficult undertaking—with the consequences of getting it wrong reverberating in new ways.
“If you’re kind of close to your forecast—either above or below—you’re in fairly good shape,” Campbell Harvey, a finance professor at Duke University’s Fuqua School of Business and a founding director of the closely watched Duke-CFO survey, told CFO Brew.
However, in periods of great uncertainty, “you can make the forecast, but you have very little confidence in that forecast,” he explained. “And what that means is that there’s a high probability that what actually happens could be much different than your forecast, and that’s where the company gets into trouble.”
No one is debating that we’re in an uncertain environment. “Is there a lot of uncertainty today? Definitely,” Harvey said. And in a sense, the prevalence of uncertainty is what makes agreeing on a definition tricky; CFOs are attributing a range of outcomes to uncertainty, but potentially using the term in different ways.
Buzzwords. Like “circle back,” “synergy,” and “touching base,” uncertainty, as a corporate term, is inching closer to workplace ubiquity (and all the overuse that entails). But while we may forever debate when to use “low-hanging fruit” instead of “a quick win,” uncertainty does have a much more concrete definition, even if it’s currently being used in a multitude of contexts.
The “easiest” definition for finance professionals is that uncertainty is a type of risk, Harvey explained. And when it comes to forecasting, uncertainty is simply “how much confidence you have in [your] forecast. Your forecast has a high, a low, and a baseline. With uncertainty, there’s a huge gap between the high and the low.”
Similarly, Margaret Franklin, CEO of the CFA Institute, a nonprofit that provides finance education to investment professionals, thinks CFOs are currently defining uncertainty the same way as portfolio managers or security analysts.
“What does the future cash flow projection look like? What are the conditions for a company to do well or not, and what does that look like? And what tools do I have available…to help with that work?” Franklin posits the kind of questions CFOs might ask to ascertain how much uncertainty is at play, and how to manage it.
When it comes to actually using the term in more public settings, Franklin notes many CFOs are using uncertainty as a shorthand for a degree of disruption to their customers, supply chains, and a “disruption to confidence broadly,” she added. And when that’s the definition, she says “there’s no reason not to wait” to make capital allocation and investment decisions “because you don’t know what the impact of inflation is really going to be; you don’t know what trade alliances are going to be acceptable or not.”
But it could be that the broad definition of uncertainty allows the word to be flung around perhaps more often than it should. “One of the key short-term objectives of CFOs is to hit the earnings target. They don’t want to fall short,” Harvey said. “With increased uncertainty, it’s more difficult to do that.”
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In that context, uncertainty becomes a way to set expectations for investors that a miss could be coming, he continued.
“We know misses are really punished in the market, but the degree of punishment depends on the uncertainty,” Harvey added. “If there’s very little uncertainty, and then you miss your target, that’s very bad. If there’s a large amount of uncertainty, and you miss, well, it’s an uncertain environment.”
Uncharted territory. Just because uncertainty, as a term, may be used loosely, doesn’t mean that it’s somehow immaterial. On the contrary, the uncertainty of the macroeconomic environment in the US is likely only going to breed more uncertainty in the future, in Franklin and Harvey’s eyes.
“People are questioning: Is the US as safe as it used to be?” Harvey said, referring to trade. “The US has got this privilege of being the reserve currency of the world. Will it be in the future? All of this causes people outside of the US to be thinking of alternatives.”
“If we look here at the US, which has been really the singularly best performing market and economy for decades, that’s being challenged in this new environment,” Franklin added. “And I don’t think any of us imagined we’d be reimagining the core fundamental market being the US market, and that is what’s happening now.”
That’s a tall order. And in the short term, there may be a benefit to ignoring some of the more immediate policy uncertainty, given how diffuse it is, Franklin pointed out.
“It’s not just what opportunity you didn’t take, but what was afforded to you by not making a rash decision in the short term,” she said. “You want to be able to have a better sense of the available information so that you can make sound decisions.”
All the while, there’s a time horizon to all uncertainty—and those who keep their eyes on longer term uncertainty may come out on top, Harvey said. Nascent technologies like artificial intelligence, for example, won’t impact what’s happening next quarter, he noted, “but it could significantly induce uncertainty over the next five years.”
Similarly, if the market nosedives, and you “panicked and sold at the low point, then waited and then bought back once the market fully recovered, then you’re a huge loser,” he said. “Some of this uncertainty…we call this time diversification, that if you hold long enough, then some of that noise in the short term will kind of go away.”
If all of this sounds like fodder for your next therapy sessions, take comfort in knowing that “it’s also the case that this is the time when high quality managers shine,” Harvey added.
In times of crisis or heightened uncertainty, that’s when “you can really separate out the [leaders] that are skilled and the ones that are just lucky to be there,” he noted. “It’s the time, especially in the finance function, in corporations, in investment management, it’s a time when, if you’re good, you can show it.”
And for those curious what the good managers are doing right now, Harvey’s advice is succinct: “Don’t overreact. Assuming that you’ve got a good strategic plan in place, stick to the plan unless you detect a structural change. Think about the long term, not the short term.”