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What is scenario planning and how does it differ from sensitivity analysis?

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Scenario planning and sensitivity analysis are two methods of assessing the impact of uncertainties and risks on a business decision or project. They are both useful tools for corporate finance professionals, but they have different approaches and purposes. In this article, we will explain what scenario planning and sensitivity analysis are, how they differ, and when to use them.

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Maulik Nagri

Experienced Finance Executive | FP&A Process Builder | Shareholder Value Creator | SaaS Finance Expert | Profitable…
Míria Oliveira

Engenheira de Produ??o | Coordenadora Financeiro | Tesouraria | Faturamento | Contas a pagar | Contas a receber |
NARAYANAN NARASIMHAN

Associate Vice President Finance | SAP S/4HANA, Financial Operations

1 Scenario planning

Scenario planning is a strategic method of creating and evaluating multiple possible future situations based on different assumptions and variables. It helps to identify the drivers of change, the critical uncertainties, and the potential outcomes that could affect the business. Scenario planning is not about predicting the future, but about exploring the range of plausible scenarios and preparing for them. Scenario planning can help to generate new insights, test the robustness of strategies, and foster creativity and innovation.

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Míria Oliveira

Engenheira de Produ??o | Coordenadora Financeiro | Tesouraria | Faturamento | Contas a pagar | Contas a receber |
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O planejamento de cenários explora a amplitude de resultados, enquanto a análise de sensibilidade foca em variáveis específicas. O planejamento de cenários é mais qualitativo, enquanto a análise de sensibilidade é mais quantitativa. O planejamento de cenários auxilia na formula??o de estratégias, enquanto a análise de sensibilidade auxilia na identifica??o de fatores crítico

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NARAYANAN NARASIMHAN

Associate Vice President Finance | SAP S/4HANA, Financial Operations
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Scenario planning involves creating detailed narratives about different future states to explore how strategic choices might play out under various external conditions. It's about understanding the impact of different external shifts on an organization's future. Sensitivity analysis, however, focuses on quantifying how changes in one or more input variables affect a given outcome, often using a mathematical model. It identifies which variables have the most impact on outcomes, helping in risk assessment and decision-making. While scenario planning prepares for multiple broad futures, sensitivity analysis provides a focused examination of specific variables' effects.

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Juan Manuel Torres Suarez

Experto en Customer Experience | Marketing enfocado en la Experiencia del Cliente | Community Manager desde el Servicio al cliente | Founder DigitalEX
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La planificación de escenarios esta fuertemente ligada a la creación de storytelling. Las historias de usuario usadas en el desarrollo de metodologías ágiles, se pueden convertir en una herramienta valiosa a la hora de buscar un punto de partida para ideas situaciones futuras que se puedan presentar, siempre desde de la perspectiva del usuario final, quien es la razón última de todos los proyectos

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2 Sensitivity analysis

Sensitivity analysis is a quantitative method of measuring how the output of a model or calculation changes when one or more input parameters are varied. It helps to assess the impact of uncertainty, risk, and error on the results. Sensitivity analysis is not about creating scenarios, but about examining the sensitivity of the output to changes in the input. Sensitivity analysis can help to identify the key drivers of value, the sources of risk, and the optimal decisions.

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Maulik Nagri

Experienced Finance Executive | FP&A Process Builder | Shareholder Value Creator | SaaS Finance Expert | Profitable Growth Driver
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Sensitivity analysis is a standard way to identify risk. Notably, the risk comes from the variability of the model inputs. A standard test under sensitivity analysis calculates the change in a key outcome (e.g., enterprise value) caused by a positive 10% change and a negative 10% change in a model input. Key model inputs generally contributing to high variability (and thus risk) include revenue growth, weighted average cost of capital, and terminal value calculation.

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Juan Manuel Torres Suarez

Experto en Customer Experience | Marketing enfocado en la Experiencia del Cliente | Community Manager desde el Servicio al cliente | Founder DigitalEX
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Este es un gran abstract de lo q es el análisis de sensibilidad y su importancia en la evaluación de modelos y cálculos. Destaca su papel en la comprensión de cómo las variaciones en los parámetros de entrada afectan los resultados, lo que es crucial para comprender la incertidumbre y el riesgo asociados. Además, subraya que el análisis de sensibilidad no implica la creación de escenarios, sino que se centra en entender cómo la salida responde a cambios en la entrada. En resumen, el análisis de sensibilidad emerge como una herramienta valiosa para identificar impulsores clave, evaluar riesgos y tomar decisiones óptimas en un contexto determinado.

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3 Differences between scenario planning and sensitivity analysis

Scenario planning and sensitivity analysis differ in several ways, such as their scope, method, and purpose. Scenario planning considers multiple scenarios that reflect different combinations of variables and assumptions, while sensitivity analysis focuses on one scenario that reflects the base case or the most likely situation. Additionally, scenario planning is a qualitative and creative process that involves storytelling, brainstorming, and scenario building; whereas sensitivity analysis is a quantitative and analytical process that involves mathematical modeling, data analysis, and sensitivity testing. Furthermore, while scenario planning is a forward-looking and strategic tool that aims to explore the future and prepare for it, sensitivity analysis is a backward-looking and tactical tool that aims to evaluate the past and optimize it.

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Ashutosh Kar

Founder & CEO | Advince – Simplifying Finance, Tax & Legal So You Can Focus on Growth | Advince Books - All-in-One Accounting Solution
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Scenario planning and sensitivity analysis are both methods used in decision-making and risk management, but they approach uncertainty in different ways. Scenario planning involves creating multiple plausible future scenarios based on different combinations of key variables or drivers. These scenarios are often narratives or stories that describe possible futures, considering various internal and external factors that could influence outcomes. On the other hand, sensitivity analysis focuses on examining how changes in one or more input variables affect the output of a model or decision. It involves systematically altering the values of specific variables within a defined range to observe the resulting changes in outcomes.

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Juan Manuel Torres Suarez

Experto en Customer Experience | Marketing enfocado en la Experiencia del Cliente | Community Manager desde el Servicio al cliente | Founder DigitalEX
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Mientras que la planificación busca presupuestar posibles eventos futuros, elanálisis de sensibilidad no implica la creación de escenarios, sino que se centra en entender cómo la salida responde a cambios en la entrada.

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4 When to use scenario planning and sensitivity analysis

Scenario planning and sensitivity analysis are complementary methods that can be used together or separately, depending on the context and the objective. Factors that can influence the choice of method include complexity, time horizon, and data availability. For instance, scenario planning is more suitable for complex and uncertain situations with multiple variables, and is more appropriate for long-term strategic decisions where data is scarce. On the other hand, sensitivity analysis is more suitable for simple and deterministic situations with few variables, and is more appropriate for short-term operational decisions where data is abundant.

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5 Examples of scenario planning and sensitivity analysis

Scenario planning and sensitivity analysis can be applied to various corporate finance topics, such as capital budgeting, financial forecasting, and risk management. When it comes to capital budgeting, scenario planning can help evaluate the feasibility and attractiveness of different investment projects under different economic, market, and competitive conditions. Sensitivity analysis can measure the impact of changes in variables such as cash flows, discount rates, and growth rates on the net present value and the internal rate of return. For financial forecasting, scenario planning can create and compare different financial forecasts based on different assumptions and drivers of revenue, cost, and profit. Meanwhile, sensitivity analysis can assess the sensitivity of the forecasted financial statements and ratios to changes in key parameters such as sales volume, price, margin, and interest rate. In terms of risk management, scenario planning can help identify and prepare for various risks that could affect the business. Sensitivity analysis can quantify and mitigate the exposure and impact of each risk factor on the performance and value of the business.

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6 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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What is scenario planning and how does it differ from sensitivity analysis?

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1 Scenario planning

2 Sensitivity analysis

3 Differences between scenario planning and sensitivity analysis

4 When to use scenario planning and sensitivity analysis

5 Examples of scenario planning and sensitivity analysis

6 Here’s what else to consider

Corporate Finance

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