What are the most common pitfalls or mistakes to avoid when doing sensitivity analysis and scenario planning?

1 What is sensitivity analysis?

Sensitivity analysis is a technique that measures how much a change in one variable affects the outcome of another variable. For example, how much does a 10% increase in sales affect your net income? Sensitivity analysis helps you identify the key drivers and risks of your business model and test the robustness of your assumptions and estimates. It also helps you communicate your results and scenarios to your investors with clarity and confidence.

2 What is scenario planning?

Scenario planning is a technique that explores how different future events and situations might affect your business. For example, how would your business cope with a sudden market shift, a new competitor, or a regulatory change? Scenario planning helps you anticipate and prepare for various outcomes and uncertainties, and adjust your strategy and plans accordingly. It also helps you demonstrate your foresight and flexibility to your investors and stakeholders.

3 How to do sensitivity analysis?

To do sensitivity analysis, you need to define your objective and scope, gather data and information, build a model and set a base case, vary one variable at a time and observe the changes, and interpret and report the results. Defining your objective and scope involves understanding what you are trying to measure and analyze, as well as the key variables and outcomes that you want to focus on. Gathering data and information requires identifying sources and methods for collecting and validating data that is reliable and accurate. Building a model involves structuring and organizing data into a logical and coherent model with assumptions and estimates for the base case. Varying one variable at a time involves changing the value or range of one variable while keeping the others constant. Interpreting the results involves drawing insights from the sensitivity analysis to present to investors.

4 How to do scenario planning?

To do scenario planning, you must first define your objective and scope, as well as identify and prioritize the drivers and factors that could influence your business in the future. Then, you need to develop and describe the scenarios by combining the drivers and factors into plausible and distinct scenarios. After that, you should analyze and evaluate the scenarios to assess the impact and likelihood of each one on your business. Finally, you should adapt and act on the scenarios by adjusting your strategy and plans based on them, as well as monitoring and updating them as new information arises.

5 What are the common pitfalls and mistakes to avoid?

Sensitivity analysis and scenario planning are not perfect techniques, and there are some limitations and challenges that you must be aware of. A common mistake is using too many or too few variables or scenarios, which can overload or oversimplify the analysis. Additionally, it is important to use realistic and consistent assumptions or estimates, as well as consider all outliers and extremes, in order to get reliable results. Lastly, it is essential to communicate and update the results or scenarios with investors and stakeholders. Doing so will ensure that they stay informed and engaged as the situation changes.