In the days that preceded the shock ‘leave’ result of the EU Referendum, CFOs were largely in favor of remaining within the EU, arguing that to not do so would lead a great deal of uncertainty that would be detrimental to their bottom line and risk jobs. However, while there was a clear consensus among financial leaders that it would have a negative impact, in a survey by market intelligence group Greenwich Associates, just 26% of CFOs who responded said their company has ‘made, or is in the process of making contingency plans for a possible British exit of the EU - 53% explicitly said that they have ‘made no such plans.’
In the days that followed the vote, finance leaders remained largely pessimistic. In a survey by Deloitte carried out five days after the EU referendum, 95% said uncertainty was either high or very high, up from 83% three months earlier. The survey also indicated higher levels of risk aversion and increased pessimism about the economy. This view has changed little in the year since, with the CBI still continuing to call on the government to ensure access to the single market - calls that appear to be falling on deaf ears.
However, it seems that CFOs are still taking a wait-and-see approach rather than taking action. In the latest research from Thomson Reuters, 69% of businesses have yet to see any impact from the Brexit vote on their strategic planning. Indeed, even among financial services organizations - believed to be among the worst hit - just 26% said that they are scenario planning for different outcomes of the negotiations.
Laurence Kiddle, managing director for the Europe, Middle East and Africa tax and accounting business of Thomson Reuters, said of the findings that, ‘The results suggest a relatively muted response from business so far – not the knee-jerk reaction that some expected. Concern for the future trade deal between the UK and the EU has understandably caused some companies to hold off from expansion; and we will continue to see decision deferral until more detail becomes clear. It is obvious that the business implications of Brexit are beginning to emerge from the mist of rhetoric and speculation.
Guy Lougher of Pinsent Masons, the law firm behind Out-Law.com agrees, adding that, ‘It’s a surprisingly small proportion of organizations that are scenario planning for different outcomes of the negotiations. I would have expected a higher proportion to be actively scenario planning given the importance of being prepared for the range of potential outcomes that may arise from Brexit. After all, scenario planning does not automatically mean that a business will take premature or precipitous action, it simply means that the business has sought to identify how it would be affected by Brexit.’
You could take the findings in one of two ways. Either there are so many unknowns in the equations that trying to come up with a contingency plan at the moment is simply pointless and a wait-and-see approach is more appropriate, or that finance leaders are overly complacent in the face of what will likely prove to be a seismic shift.
The ‘hope for the best’ approach is, given some of the rhetoric around negotiations so far, borderline ridiculous. Just this week European Commission president Jean-Claude Juncker criticized the UK's Brexit negotiations, saying none of the papers provided so far are satisfactory, while EU chief negotiator Michel Barnier said Brexit secretary David Davis had to ‘start negotiating seriously’. Others have been little more positive. The consensus at the moment seems to be that the UK is not set for any deal at all, let along a good one for businesses.
The CFOs must not remain passive in the face of such turbulence, particularly when the most likely outcome is so negative. Companies have got to do their contingency planning to weather the stormy waters likely to continue for at least the next several years.
There are several important things to consider here. US companies and others outside the UK have to ensure that they limit their exposure to potentially volatile currencies. UK-based CFOs, on the hand, must focus on ensuring they have liquidity at hand. Brexit will almost certainly result in funding costs for UK corporates going up, and CFOs need to look at their spending plans and increasing sources of liquidity to ensure they have enough in reserve.
Finance departments from all regions also have to be more flexible in their forecasting. This is far more easily achieved today thanks to advancements in new data technologies and cloud technology, which have enabled rolling forecasts. An AFP study recently revealed that 44% of finance professionals have turned to continuous forms of planning, as old methods become increasingly less viable. With a rolling forecast, executives are able to make decisions that reflect changes and trends in their industry or business, manage cash flows to anticipate risks, and set shareholder expectations according to the most recent possible projections.
This kind of agility needs to be a priority in all functions during uncertain times. Strategies need to be adapted and risks mitigated against. Big data is of particular importance in predicting the negative ramifications of an event like Brexit and how best to mitigate against them. For example, BlackRock has introduced one data initiative that attempts to identify a potential recession before it occurs by mining senior management’s conversations for signifiers to gauge the economic outlook. Every quarter, the financial services firm mines 3,000 earnings conference calls and compares the topics and language used by CEOs and CFOs, looking for any minor changes in their language that could suggest a change in thinking around a topic. In their blog, they claim that ‘Rather than relying on a few anecdotal bits of evidence, big data allows us to measure exactly how much more frequently words like ‘recession’ have crept back into use. We can then decide if we should be worried, too.’
Data analytics can also be used to help identify solutions. For example, how customers’ purchasing habits have been affected. They can adjust their marketing and product strategies accordingly before major damage is done. Using predictive analytics models also allows companies to cut investment to parts of their business that may not be working while also ensuring that cutting them will not stifle long-term growth when the economy recovers.
Another thing CFOs should consider is zero-based budgeting (ZBB). ZBB was first introduced in the early 1970s by an accounting executive at Texas Instruments called Peter Pyhrr. Pyhrr was brought on to help Jimmy Carter first in his role as Georgia governor, where ZBB was adopted at state level, then as the President of the United States. The idea was that, while in traditional budgeting, the previous term’s expenditures are counted up and increased by a small percentage for the following term, with ZBB, you are preparing the budget from scratch with a zero-base. In ZBB, all spending must be justified by demonstrable needs and costs, and accounted for in each new budgeting period, and every department is analyzed for its needs and costs.
ZBB has many advantages. According to global management consulting firm McKinsey & Company, a well-implemented zero-based budget can save large corporations 10-25%, sometimes as early as six months after implementation. It allocates financial resources basing on planning requirements and results. It is proven to reduce expenditure by providing a clearer picture of costs against targets and KPIs. It improves accuracy by making every department look at data at a more granular level, and to constantly re-examine each and every item of the cash flow and compute their operation costs. It also leads to increased efficiency through improvements to the allocation of resources brought about by looking at actual rather than historical numbers and motivating managers to look for alternative plans. All of this can help prepare an organization for any shocks that could arise during the kind of turbulence we are likely to see after Brexit.
We are entering a world of uncertainty. CFOs who have no contingency plans in place are going to have to adapt quickly if they are going to cope with the kind of risk we now face. Technology will help them do that to a degree, but even in a digital world where you can react almost instantaneously for events, taking action, especially in a large company, is slow, and businesses must have contingency strategies in place ahead of time or risk being destroyed.