Forecasting Series #1: What Does a Number Mean?
Cashflow forecasting is back in vogue as a topic and activity. The recent liquidity crisis is driving many to improve their ability to forecast cashflows. This blog entry is one of a series meant to identify forecasting issues, ideas as well as offer some prescriptive advice to treasury professionals responsible for liquidity management.
What does a number mean? Watching C-Span isn’t a favorite past-time of mine, however, I found myself enjoying a conversation with C-Span going on in the background (it wasn’t my house). One of our financially astute member of congress was questioning Tim Geithner. He, the congressman, was on a roll (or rant) about mortgages. Stating something like “…many homeowners now have a negative loan to value ratio…” Yes, he said negative. If Mrs. Grundy, the proverbial 5th grade math teacher, heard this I am sure the ruler would have come out and would have returned without reddening someone’s knuckles. The mathematical challenge of making the LTV ratio requires something strange – a negative loan (can I get one of those?) or a negative value of a home. The congressman probably meant negative equity (or a very high LTV). Enough about our elected leaders and new math.
How accurate is your forecast? We see more and more regularly people quoting accuracy levels such as “…we achieved a 95% accurate forecast…”. Really? Is that good? Is this wonderful? What is it based upon? The number by itself is pretty useless. It is akin to saying “we achieved forecasting accuracy at level orange”. Of course, if you say that, people will look at you strangely and place a discrete phone call with the assumption that white will be your new color. But, if you mention a number or percentage – that must be scientific…accurate…and based entirely on facts. So what does this % of accuracy mean?
- Is this accuracy based on cash flows or cash balances? And, if cash balances, are required reserves factored out of the equation?
- What is the timeframe for the forecast? One day? One week? One month? 90 days?
- What is the period of the forecast? A single day? A calendar week? A month – or 4 week period?
- Is the percentage based upon absolute value of difference? Is the denominator the forecast?
To state the obvious – numbers need to mean something. And to do that we need context. Ask a young child “How many are you” or “How old are you”. They will respond something like “Three” very proudly. Then ask them “three what?” The puzzled look is precious (it isn’t mean to do this, I checked).
“So, what is your forecasting accuracy?”
“95%”.
“95% of what?”.
Puzzled look…(this one isn’t so precious).
In this series we will also lay out a methodology for describing forecasting accuracy that includes the period, basis, etc. That way everyone will understand the context of the numbers that are used. And, remember to watch out for negative LTV ratios. That indicates, with confidence, that it is time to check the math, the mathematician or both.
Comments? craigj@strategictreasurer.com
/caj
Treasury: Situational Awareness – Lehman and San Mateo County
February 24, 2010’s WallStreet Journal ran an article entitled Lehman’s Ghost Haunts California. This article is well worth a good and critical read. Emphasis on the critical. It covers, essentially, one side of the story about San Mateo County and their loss of $155mm (reported by them) from the collapse of Lehman Brothers. We’ll be more frank in this blog entry even if it makes people feel uncomfortable.
The article states that “San Mateo’s board of supervisors ordered an independent review of the way the county investment fund was run, but found no wrongdoing.” And, a little later “San Mateo’s treasurer had invested in highly rated securities and put no more than 10% of the fund in any single issuer.” Okay, no laws were broken. Nobody violated the written investment policy as written. However, this fails to tell all of the key points about what was going on at the time. I would like to see the reporter dig up some useful information to tell us – such as:
“If there are warning signs all over the place about ice on the road - and snow is falling, anyone who doesn’t slow down to adjust for conditions is responsible for flying off the road. Claiming they didn’t break the posted speed limit isn’t going to be a good argument – especially if they were accelerating into the corner when they hit the ice.”
The article highlights a push to try to secure bailout funds for municipalities that held Lehman paper and makes comparisons to the bank bailout. While we can all argue about appropriateness of the ‘voluntary’ capital infusions to banks, there are some important differences that are not noted:
Lessons Re-Learned:
If anyone thinks that reducing treasury staff levels or eliminating funding for treasury systems and tools is a good idea, they may need some shock therapy or recent (and old) history lessons. However, no system can completely prevent operator error.