Sensitivity Analysis

What is a sensitivity analysis?

is a technique which allows the analysis of change in assumptions used in forecasts

What is sensitivity analysis used in?

a very useful technique for use in investment appraisal

What assumptions need to be made by management as they prepare forecasts?

cash flow forecast
budgeted profit
investment appraisal
breakeven analysis

What assumptions need to be made about cash flow forecast?

timing of cash inflows and outflows
amount of cash inflows and outflows
receivables and payables days

What assumptions need to be made about budgeted profit?

sales volumes and unit selling prices
gross profit margins and overheads

What assumptions need to be made about investment appraisal?

timing and amount of project cash flows
period over which project will run
amount of initial investment

What assumptions need to be made about breakeven analysis?

average selling prices and variable costs
fixed costs by category and total

What does sensitivity analysis help answer?

how reliable the assumptions made are
what happens if assumption are different in reality
which assumptions are most significant

What does sensitivity analysis allow?

allows key assumptions to be changed to analyse effect

What does sensitivity analysis help to judge?

it helps judge the degree of risk

What does sensitivity analysis recognise?

recognises that there is no such thing as an accurate forecast

What does sensitivity analysis consider?

considers one variable or assumption at a time

What are the benefits of sensitivity analysis?

identifies the most significant assumptions
helps assess risk and prepare for a less than favorable scenario
helps make the process of business forecasting more robust

What are the drawback of sensitivity analysis?

only tests one assumption at a time
only as good as the data on which forecasts are based
a somewhat complicated concept which is not understood by all managers