Sensitivity Analysis

You often have to forecast business results or analyze investment proposals by making assumptions on a number of parameters. The key assumptions may relate to revenue (price, volume, mix), costs (fixed vs. variable, material vs. labor, etc.) or other variables (capital invested, etc.). A presentation on such a business outlook should always include a sensitivity analysis and a discussion of potential scenarios. The way I suggest to do this:

(1) Identify the key metric used to evaluate the business or the investment proposal (in the example below: Return on Sales).

(2) Show on one slide which assumptions potentially have the biggest impact on this metric.




(3) Take the two or three most critical variables, and calculate how the key business metric would look like of you change the base assumption to an optimistic scenario vs. a pessimistic scenario.

If you do this only for two key variable, it’s quite easy to show it graphically – a simple 3×3 matrix (or you can even do a 5×5 matrix with more gradual scenarios). If you do it for three key variables, you will have to work witha tree structure and multiple matrices – as shown above. You can also highlight in color which scenarios fulfull a certain threshhold. For example, if your company has a minimum requirement of a 5% Return on Sale, all boxes where the ROS is below 5% could be colored in red.