How to keep a clear head when uncertainty grows
In a time when it’s nearly impossible to tell what is happening in politics and the wider economy, John Stokdyk scans the horizon and suggests a few strategies to cope with the regulatory, business and technology trends buffeting UK business.
We began the year with a summary of where accountancy was supposed to be heading, and where it actually was. Yet with the first step of Brexit almost done, fear, uncertainty and doubt are still rife within the profession.
Even the most clued-up accountants are wondering what is happening to the UK economy and compliance regime as the country loosens its ties to the European Union. And with automation looming on the horizon, what is going to happen to accountancy jobs over the next three years? Even that could be a trifle compared to the increasingly dramatic climate crises we’re witnessing.
All these fears are valid – but the first thing we need to accept that change is inevitable. There is always going to be a lot of it happening. Often, the driving forces are interdependent, so it’s hard to pick out the issues you need to prioritise.
As our 2020 predictions article highlighted, in the three years since the 2016 Brexit vote most UK accountants sat on their hands and waited for the situation to clarify itself.
This article acknowledges the uncertainties that are now a part of the typical accountant’s working environment, but not doing anything is a decision in itself. Instead of standing on the sidelines watching passively, the point is to recognise you can be an active player who can do something positive to manage change.
We will draw on the examples and advice of effective forecasters and planners who embrace uncertainty and present some guiding principles you can apply to your own planning activities.
The wisdom of Donald Rumsfeld
The first guiding principle comes from Australian “emerging future” practitioner Maree Conway who says the more clarity you can have about where you are going in the near future, the wiser your decisions will be today.
The next piece of advice comes from Reanna Browne, who admits that while we can’t predict the future with absolute certainty, “What we can do is expand our thinking around it.”
The third step on the ladder of uncertainty goes back to the famous formula of US defence secretary Donald Rumsfeld, who attempted to mark the differences between “known knowns, known unknowns and unknown unknowns”. Rumsfeld was ridiculed for his apparent simple-mindedness, but he was setting out the prevailing theory of military planners who use these graduations to hunt for information that might give them an edge on the battlefield.
In the previous article on 2020 predictions, Xero UK country manager Gary Turner extolled the benefits of “situational awareness” and nodded in the direction of more recent thinking embodied by the VUCA model, which encompasses volatility, uncertainty, complexity and ambiguity.
VUCA - sources of uncertainty and doubt
The VUCA model takes known and unknown factors and arranges them into four quadrants based on the degree of knowledge you have about the issue and the likelihood of it taking place:
|Complexity – high predictability, with good level of knowledge
||Volatility – defines issues that have a situation with high predictability, where you have little knowledge about the duration or impact it might have.
|Ambiguity – low predictability, with low level of knowledge – the “unknown unknowns” where no precedents exist.
|Uncertainty – good knowledge of causes and effects, but the predictability of the event is low:
Source: Nathan Bennett and G. James Lemoine, Harvard Business Review, Feb 2014
Now that you are able to classify different kinds of threat to your situation, what can you do about them? Each of the responses suggested by Bennett and Lemoine are relevant for any finance professional. The basic principle is to stay curious and alert to the signals around you and to pay attention when you start to see social, economic, technological and environmental changes happening. And, as well trained accountants, you’ll know that involves collecting reliable measures.
When reliable data is not available, start gathering and analysing your own, suggested ‘Freakanomics’ authors Stephen Dubner and Steven Levitt.
Forecasting: use probabilities to cope with uncertainty
Historic data such as financial results are a reliable starting point, but determining the factors that may have influenced any surges or contractions and projecting these drivers into the future is more of a challenge.
The UK has been going through a lesson in uncertainty for the past three and a half years around Brexit. Until 12 December 2019, there were three basic scenarios: Brexit would either happen with or without a deal, or the whole initiative could have been called off.
Even as the December election neared, it was instructive to hear BBC political editor Laura Kunessberg talk about the difficulty of being able to predict “with any degree of certainty” what was likely to happen with the latest compromise deal. Her comments were a signal that probabilistic thinking is a core part of the political correspondent’s toolkit. If people in Westminster are doing it, it might be a useful way to model how those uncertainties could play out in other scenarios, such as business.
The most famous exponent of these techniques is Nate Silver, who in his book ‘The Signal and the Noise’ explains how probabilistic models helped him accurately predict how the 538 congressional districts would vote in the 2008 election to put Barack Obama in the White House. The book also applies mathematician Thomas Bayes’ approach to the 2007-8 financial crisis, weather forecasting and baseball.
The Bayes technique sets out from a model based on known facts and applies probabilities to different potential outcomes. When new facts are encountered, the probabilities can be recalculated and the model adjusted. Philip Tetlock and Dan Gardiner built on these ideas to describe the process of ‘Superforecasting’, which trains in past probabilities and constantly refines predictions as you collect new data.
So if Brexit uncertainty has thrown all your recent budgets out of whack, stop fretting about it. The modern, agile way is to adapt to such missteps and use them to recalibrate your forecasts – as many organisations now do with rolling forecasts.
These probabilistic approaches are closely related to principles that most accountants learn in the risk management modules of their qualification syllabus.
So let’s apply them to Brexit. The first thing effective forecasters do is put their biases to the side and focus on factors they can quantify and estimate. In this situation, a finance professional needs to focus on potential business impacts, not politics.
With the enactment of Article 50 and signing of the EU withdrawal agreement, the remain option is no longer part of the equation, which narrows the probability model down to different negotiated trading arrangements – the most likely outcome, but based on an as yet unquantified menu of options – or a hard break that would involve negotiating a separate set of agreements with Europe and other trading partners through the World Trade Organisation.
While attempting to negotiate a compromise exit solution, the Treasury and Department for Exiting the European Union (shut down on 31 January 2020) feverishly researched the potential impacts of a no-deal Brexit on areas ranging from fisheries and farming to data protection, legal, trade and tax arrangements.
A lot of these are likely to affect your organisation, so start breaking down the problem into different components and analysing the potential impacts.
The Brexit forecasts produced by the Bank of England included continuity/compromise/clean break charts that offer a handy analogue for the forecaster’s other big friend, the best and worst case scenarios.
Project some simple scenarios
The effects of Brexit are already evident in the GDP growth rates in the UK economy during 2016-19. Thanks to the prevailing uncertainty, many businesses scaled back investments to hoard cash for unexpected contingencies.
In January’s Accounting Excellence Talk on cashflow, the panellists endorsed the “cash is sanity” outlook and described the benefits of building cashflow forecasts. The kind of 30-day forecast that Xero is planning to build into its core product can alert a business to whether it will be able to make the payroll run at the end of the month.
But Clare Blackmore, the head of cloud at Albert Goodman, works with a financial modelling team that uses Power BI and Excel to build 12-month cashflow projections to help clients assess longer term opportunities and finance needs.
The Albert Goodman advisers regularly return to those cashflow forecasts and compare them to actual figures to explore the reasons for any variances. The rolling forecast provides invaluable insights into underlying business drivers to inform forward-looking business decisions. It also provides a platform for further “what-if” projections – for example, an import/export business could build best and worst case scenarios to look at the impact of rises or falls in Sterling’s value on the 12-month cashflow.
The Sterling/cashflow example is a practical first step into “what if” scenario building, but there are so many other uncharted territories that imaginative planners can explore. Brexit isn’t just going to affect GDP growth and currency rates. It’s going to introduce numerous changes in the compliance regime – including new VAT reporting and collection arrangements – along with supply chain and staff retention and recruitment issues. Then there are the changing terms and conditions already mentioned that could affect specific industries and sectors.
We haven’t yet touched on one of the biggest imponderables – climate change, which is already having significant impacts in the increasing frequency of flooding, storms and wildfires. As motor manufacturers discovered this week, it would be sensible to review their forecasts and devising new hypotheses to identify the impact of a hydrocarbon engine ban from 2035.
The increasing speed of technology change is a factor that AccountingWEB has considered before, taking in the probabilities around Making Tax Digital 2.0 and other emerging trends such as fintech and Open Banking, blockchain and artificial intelligence.
Proforecast’s Mark Harrison cited technology in the retail sector as an example of planning and forecasting in a disrupted market. In the space of a few years, online shoppers overturned traditional retail cycles. As a result, retailers had to adjust their typical end of season sales in response to events such as the November Black Friday surge driven by Amazon, he argued. Basing forecasts on historical patterns will no longer hold water in such disrupted markets.
“To have a credible forecast you need to make judgements based on multiple scenarios, such as changes in buying habits and peak sales times, introducing new products more frequently than has been done previously, flexing your work force around these new dynamics,” Harrison advised.
Plan, decide, implement and review
So far, we’ve mainly talked about theories that many accountants have probably modelled in Excel spreadsheets. Thanks to developments in modern financial software, dedicated tools can make forecasting much faster and more useful. This is whether you are using Float or Fluidly to construct a cashflow forecast, or flexible advisory tools like Fathom, Futrli or Spotlight Reporting to model different scenarios around financial and non-financial measures.
Xero’s Gary Turner makes the case for adopting these tools to deal with VUCA scenarios. “Business is inherently more complex than it was 15 years ago. Even if you’re a small retail business and selling online and taking orders on multiple channels, you’re dealing with business models that have many more dimensions. And you’ve got an increasing number of compliance obligations such as late payment and gender gap reporting.
“There’s no one spreadsheet that’s going to manage your business affairs. The complexity of modern management will defeat it.”
Turner also thinks that basic financial disciplines like recording transactions as they are incurred, flexing the impacts through your forecasts and reporting and communicating the trends more frequently can play a big part in counteracting uncertainty.
“Insight needs to be weekly, if not real time,” he says. “We’re in a world of high frequency management, where the impacts of change are hard to measure and mitigate. So you can’t run your business on monthly reporting, where you might get a report and work out if you made a profit halfway through the next month.”
As well as building business models and forecasts, cloud tools of the kind Turner advocates should get you thinking about the data flows that feed into them. If you found it was feasible to plug sales pipeline estimates, Google Analytics or employee engagement measures into your financial performance models, could they help you identify correlations that would improve the sensitivity and predictability of your forecasts?
Practice being strategic
The most effective piece of advice is probably the simplest of all: just build a bit of time into your schedule to experiment with some of the business planning techniques and involve others in those efforts.
Stop using a lack of facts as an excuse not to act. Create a few basic benchmarks from your own known knowns and go consult colleagues, clients or professional advisers to compile your own risk assessment framework. As you start to explore alternative scenarios and measure your estimates against actual outcomes, you’ll be better able to do some theoretical stress testing before you have to confront the issues or threats for real.
Consultant Ben Baran endorses this collaborative, experimental response. Responding to uncertainty with small, fast and cheap failures can strengthen trust, agility and resilience within your team: “Without those elements, you’ll never be able to create, fail or learn effectively together.”
If you’ve used some of these tools and techniques to identify threats and changes that will most probably affect your business, what are you going to do about them? The final part in this article series will grapple with the challenges of implementing change.
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AccountingWEB’s Head of Insight has been with the site since 1999 and likes to spend his time studying accountants’ technology habits. When not nerding out, you can find him exploring obscure indie music and searching for the perfect organic sourdough loaf from his base in Brighton, UK.