How can you use sensitivity analysis to support your pitch?

In a sensitivity analysis if you are pitching as a business unit operator, it is important to focus on income statement type (revenue projections, cost of sales, gross margin, fixed expenses, variable expenses, net margin, etc.) and other variables that are in your control. CFOs allocate capital based on positive NPV projects with IRR’s that equal or exceed the firm’s WACC (weighted average cost of capital) as a hurdle rate. Likewise, private capital is interested in return on invested capital at debt refinancing or equity exit. You can use a pro forma cash flow model to “back test” discrete inputs (i.e., range boundary of sensitivity) using goal seek functions, for a given cost of capital, discount rate, NPV, IRR, terminal multiple, etc.

Before jumping into the main topic of this article, let us understand what exactly is 'Sensitivity Analysis'? - In technical terms, sensitivity analysis is a method of changing/adapting one or more variables in a model based on different scenarios to observe how the output changes. - imagine you are the coach for your school cricket team and have developed a model with various factors like the team's batting average, bowling strike rate, etc but missing some inputs such as What if the team's star batsman scores 10 runs fewer than expected or their best player gets injured and can't play? By running these scenarios through analysis you can assess the sensitivity of the predicted win probability to these above inputs.

Building a pro forma cash flow model that features periodic (monthly or quarterly) rate of change or discrete value inputs is critical. Ideally such model is built using data ranges with spreadsheet functions to change each input automatically. Specific events (timing, revenues, expenses) can be captured (new plant coming online, product licensing opportunity, upsizing sales force and/or servicing to new region, etc.) You can select and label sensitivity “cases” based on data ranges, timing, and combinations of these inputs. As likely you know your cost of capital terms, that can be used to assess feasibility.

To run a sensitivity analysis, you need to develop a model, in this case, a financial model that has the company's future cash flow projected and the valuation based on the cashflows as well. I'm assuming we have built this model using Excel so now we have to go to the Data Tab>Data Tables>Goal Seek and change one or more input variables and generate a range of output values. Based on your preferences, you can create a chart/graph or dashboard to visualize the results and highlight the key findings as stated on my left in the article itself.

Doing the market research and having the business unit historical experience is critical for confidence in the types of inputs used for the pro forma cash flow projection. If you cannot answer simple questions like how did you determine “…[X] initial input value?” …or “…the rate of change for [Y]?”, then go back and research that, and update the model. For pre-revenue or early-stage companies, or established firms launching a new product or service / entering a new region: in my experience the revenue growth projections to attain break-even are usually unrealistic – because the analysis of the market opportunity (total addressable market TAM, service addressable market SAM, service obtainable market SOM) is flawed.

It completely depends on you and your idea of how you want to perform the valuation and present it in the pitch. Usually, one chooses the variables that are very much correlated to each other and have the most influence on the value of the company. - For instance, if you are valuing a Banking company you can show a sensitivity analysis showing how a change in the bank's NII, changes the EPS of the bank and the overall valuation. - To conduct the sensitivity analysis on the banking company's valuation, you would typically vary the NII by certain percentages (e.g., +5%, -5%, +10%, -10%) and observe the corresponding changes in EPS and overall valuation.

For a pro forma cash flow projection, preparing three cases (management’s base case, upside case, downside case) is useful. The explanation of the variables in management’s base case will attest to the robustness of the model and demonstrate the credibility of the presenter. Linkage to the business strategy and specific tactical events is compelling. For financing, the cases can also be extrapolated against different cost of capital, discount rate, rNPV (risk adjusted NPV), IRR, terminal multiple, etc. with results arrayed in a tabular format. For a valuation, the use of such multiple valuation techniques helps develop a range for discussion.

Using a sensitivity analysis always helps elevate the pitch. It helps the client understand various scenarios, assumptions, and the value creation under the same. This leads to better visibility as well as helps address their questions and concerns. This also emphasizes that your model is flexible and can adapt to changing circumstances. This builds trust and confidence in your projections.

Sensitivity analysis can be used to strengthen your pitch by pinpointing important factors that affect financial estimates. Create scenarios, evaluate their effects, and emphasize important details to demonstrate a thorough grasp of the business's susceptibility to different circumstances. Reduce risks, respond to investor concerns, and provide the analysis visually to improve understanding. Stress the importance of the main value drivers, match scenarios to the strategic goals, and get comfortable expressing the results. By tailoring the analysis to your target audience, you may increase the persuasiveness and knowledge of your pitch while fostering confidence and showcasing a proactive approach to risk management.

To improve your pitch using sensitivity analysis; - Adapt your presentation style and level of detail to your audience's technical expertise and interest level. - Relate the analysis to real-world examples or familiar concepts to make it more engaging and relatable. - Show how the sensitivity analysis adds value to your proposal and strengthens your case for investment or support.

Leveraging sensitivity analysis elevates pitch development. As an expert, I emphasize its role in refining proposals. By testing assumptions, we anticipate risks and seize opportunities. Integrating this method showcases strategic acumen, enhancing stakeholder confidence. In today's competitive landscape, precision is paramount. Sensitivity analysis is our tool for strategic excellence, affirming our commitment to informed decision-making and innovation.

Sensitivity analysis and the range of valuation techniques for a firm can facilitate construction of a pro forma cash flow model around a target; then inputs suitable for that result can be estimated. In the capital markets, the specific price or value and terms that a counterparty transacts with that firm is the most compelling – until the next comparable transaction.