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How can sensitivity testing improve your decision-making?

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Sensitivity testing is a powerful tool for corporate finance professionals who need to assess the impact of different assumptions and variables on their financial models and decisions. It can help you identify the key drivers of value, the sources of uncertainty, and the potential outcomes of different scenarios. In this article, you will learn what sensitivity testing is, how to perform it, and how to use it to improve your decision-making.

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Teddy P.

Chief Financial Officer at Paylabs | Finance Operations, FP&A, Commercial Finance, Business Finance, Financial…

1 What is sensitivity testing?

Sensitivity testing is a method of analyzing how the output of a financial model changes when one or more input variables are changed. It can be used to measure the responsiveness, elasticity, or volatility of the output to changes in the inputs. For example, you can use sensitivity testing to see how the net present value (NPV) of a project changes when you vary the discount rate, the growth rate, or the initial investment.

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RODOLFO DAVIS CONTRERAS

Director Financiero de Grupo en EQUIVER con experiencia en crecimiento de ingresos
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Las pruebas de sensibilidad son el equivalente a una brújula en la navegación y funcionan como el soporte de la toma de decisiones. Si mis ventas bajan un 10% en ?cuánto impacta mi resultado? 5%- 7%- 20% Si mi margen bruto de utilidad baja un 10% ?cuánto impacta mi resultado? 5%- 7%- 20%. Cuanto impacta un quebranto en el resultado, seguramente más del 100% del monto quebrantado. Si mis gastos de administración bajan 10%, y así y en el mismo sentido hacia el incremento. Esto nos dice a qué debemos poner atención prioritaria en el manejo de las finanzas corporativas: ?son los gastos? ?evitar quebrantos? ?mejorar el margen bruto de utilidad?

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Teddy P.

Chief Financial Officer at Paylabs | Finance Operations, FP&A, Commercial Finance, Business Finance, Financial Modelling Expert | B2B Services, Hospitality, and Airlines Industries
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Sensitivity testing is one kind to test our model and its output toward different assumption given to its input. Those assumptions can be various, from economic changes, customer behavior, tax policies, required rate of return by investors, supplier's policies, up to man power planning (MPP). Before going advanced to use this test for decision making, sensitivity testing can be used also to see if our model is reliable and reasonable enough to be used for performance forecast, decision making, performance monitoring, etc.

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2 How to perform sensitivity testing?

There are different ways to perform sensitivity testing, depending on the complexity and purpose of your financial model. The simplest way is to use a one-way sensitivity test, which involves changing one input variable at a time and observing the change in the output. You can use a spreadsheet software like Excel to create a data table that shows the output for different values of the input variable. You can also use a chart or a graph to visualize the relationship between the input and the output.

A more advanced way is to use a two-way sensitivity test, which involves changing two input variables at a time and observing the change in the output. You can use a spreadsheet software to create a matrix that shows the output for different combinations of the two input variables. You can also use a contour plot or a surface plot to visualize the relationship among the input and the output.

Another way is to use a scenario analysis, which involves changing multiple input variables at a time and observing the change in the output. You can use a spreadsheet software to create a scenario manager that shows the output for different sets of input variables. You can also use a sensitivity analysis tool like @Risk or Crystal Ball to simulate the output for different probabilities and distributions of the input variables.

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Teddy P.

Chief Financial Officer at Paylabs | Finance Operations, FP&A, Commercial Finance, Business Finance, Financial Modelling Expert | B2B Services, Hospitality, and Airlines Industries
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Before perform sensitivity testing, we should gather all required information as many as possible from related users, filter those information and convert into assumption. The discussion with users can be back and forth, to ensure that this assumption is the correct one to perform scenario analysis and improve the model as well. Before perform the test, please store those assumptions into one sheet/file/folder, so we can maintain them in the future. And please ensure that the model has output sheet to summarize all of the results from test. Agree with the writer, if our test just involve few variables (up to two), Excel can execute it well. But if test involves three or more variables, we should use more sophisticated tools.

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3 How to use sensitivity testing to improve your decision-making?

Sensitivity testing can help you improve your decision-making in several ways. For instance, it can help you understand the impact of uncertainty and risk on your financial model and decision by changing the input variables to see how sensitive your output is to different assumptions and scenarios. Additionally, it can help you identify the key drivers of value and performance by seeing which input variables have the most or least effect on your output, as well as which ones have a positive or negative effect. Moreover, sensitivity testing can aid in comparing and evaluating different alternatives and options by changing the input variables to see how your output differs for different choices and trade-offs, as well as how it responds to different scenarios and contingencies. This can be beneficial in selecting the best option or combination of options for your financial model and decision.

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Teddy P.

Chief Financial Officer at Paylabs | Finance Operations, FP&A, Commercial Finance, Business Finance, Financial Modelling Expert | B2B Services, Hospitality, and Airlines Industries
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Sensitivity testing can help decision making in so many ways: 1. It continuously help us to improve financial model, 2. It help us to understand more about the business and its impacting variables/events, 3. Increase awareness of management and related users toward the business results that come from all of the given assumptions/scenarios, 4. It continuously help us to evaluate the assumption for the model.

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4 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can sensitivity testing improve your decision-making?

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1 What is sensitivity testing?

2 How to perform sensitivity testing?

3 How to use sensitivity testing to improve your decision-making?

4 Here’s what else to consider

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