Sensitivity analysis is a technique which allows the analysis of changes in assumptions used in forecasts.
Assumptions
Cash flow forecast: Timing and amounts Budgeted profit: Sales volumes and unit selling prices Investment appraisal: Timing and amount of project cash flows over a period Etcetera
- What if assumptions are worse by 10%?
Benefits and Drawbacks
Benefits
- Identifies the most significant assumptions
- Helps assess risk and prepare for a less favourable scenario
- Helps make the process of business forecasting more robust
Drawbacks
- Only tests one assumption at a time (many assumptions may be linked)
- Only as good as the data on which forecasts are based
- A somewhat complicated concept—not understood by all managers