The stochastic element, which emphasizes randomness, enables The Principal to spot potential blowups. The modeling generates a wide distribution of scenarios, which Lillis uses to determine how much capital the company needs to hold in 99 percent of all possible outcomes, from the best to the worst cases of economic performance. Says Lillis, "It helps us deal with tail risk" — those potential futures that are several standard deviations from the mean. The model also projects items such as cash flow from investments versus the surrender of liabilities, critical for a company that uses asset-liability management.

While 10-year (and even 5-year) forecasts may appear anachronistic at a time when so many companies say they are "in the dark," some industries demand them. At Bonny Doon Vineyard near Santa Cruz, California, it can take 5 years to go from vine planting to bottling. CFO Lisa Kohrs employs a 10-year forecast of revenues and liabilities, factoring in items such as vineyard labor costs, cellar costs, and eventual selling prices in four different channels. To complicate matters, the business is managed as three different companies affected in different ways by environmental, regulatory, and economic forces. Current projects are as diverse as developing a new 300-acre estate vineyard and building a new tasting room.

Whether companies think long- or short-term, the ability to react quickly to events is really all that CFOs can ask of forecasting, say experts. An all-out drive for pinpoint accuracy, especially in light of current events, can be less helpful. The Principal's forecasters, for example, did not foresee the huge drop in equity indexes this past year. "The value of [forecasting] is directional," Lillis says. "If I say to our finance people that the best estimate of our earnings is not good enough, the question becomes, What can we do about it? What drivers do we have to change? Are they within our control? If so, do we pull the lever?"

Drivers Wanted
Generating timely, reliable financial forecasts that help executive management implement decisions faster requires using true driver-based forecasting — tracking the operational measures (such as hours of temporary labor required and associated labor rates in a manufacturing plant) that have a decided financial effect, says Tony Levy, director of product marketing at software firm Cognos (now owned by IBM). Finance personnel have to think in terms of business factors instead of dry lines on a general ledger. For a telesales organization, for example, the drivers might be dollars per deal or the conversion rate of customers — measures that can be influenced by performance.

At W.W. Grainger, a $6 billion distributor of industrial supplies and equipment that averages 120,000 transactions per day, company operations include more than 600 branches, 18 distribution centers, and multiple Websites worldwide. Finance personnel are embedded in the company's business units, such as product management, business development, and marketing. The key to Grainger's business is high inventory availability and service levels at walk-in customer sites, as well as next-day delivery from distribution centers. By sitting alongside internal business partners, finance personnel get a much closer view of things like demand, product uptake, the success of new-product introductions, and supply-side trends. "We rely on sales-force input, marketing analytics, and supply-chain feedback that filters through to finance," says Ronald Jadin, Grainger's CFO.

Finance people can also draw a bead on crucial economic factors like inflation. They get the "micro" view on price increases that suppliers may be planning to pass along, and those increases are entered into Grainger's quarterly forecasts to supplement any macro analysis on inflation that Grainger gleans from economists, Jadin says. The quick relay of information also enables Grainger to better manage the price increases suppliers may try to pass on due to rising commodity costs. "We try to get them to hold off passing along inflationary pressure to us," Jadin says, "by limiting price increases to the annual publication of our catalog."

The company's forecasting process also focuses on contingency planning for a downturn. The company plans three to five major actions it might take if the economy were to soften. "The business units commit to it — that strips the emotion out," Jadin says. "If the problem arises, you just execute the plan."

For satellite services provider Hughes Communications, the most material determinant of the company's profitability is consumer uptake of services. Projections of profit and loss, cash flow, and the balance sheet depend heavily on a three-year model of new consumer subscriptions — the only forecast that Hughes updates every month. The forecast is so important that it can affect investment decisions such as whether or not the company should launch its own satellite (a $400 million prospect) or continue to lease transponders from others, says finance chief Grant Barber.

By staying close to call-center orders and new installations, Hughes took preventive action ahead of the economic downturn two months ago. The company gave Internet service consumers the option to pay equipment and installation fees over time instead of all upfront, which Barber says kept new installations from stalling. "We're constantly turning the knobs and making changes to the consumer models," he adds.

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