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What are the most important factors to consider when performing scenario analysis?

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Scenario analysis is a powerful tool for investment bankers to assess the impact of different assumptions and events on the value and performance of a company, project, or portfolio. It helps them to identify the key drivers and risks, evaluate the range of possible outcomes, and communicate their findings and recommendations to clients and stakeholders. But how do you perform scenario analysis effectively and efficiently? Here are some of the most important factors to consider.

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Jeetain Kumar, FMVA?

I help students & executive in finance ? 35 Million Views ? 51k ? KPMG Certified Financial Consultant ? ESG & FP&A…
Matheus de Souza Barboza

Finan?as | E-commerce | Marketplaces | Estratégia | Consultor | Conselheiro | Board Member | C-level | Valuation | CEO…

1 Define the purpose

Before you start creating scenarios, you need to have a clear idea of what you want to achieve and what questions you want to answer. For example, are you trying to estimate the fair value of a target company, test the feasibility of a new project, or optimize the capital structure of a portfolio? Depending on your purpose, you may need different types of scenarios, such as best-case, worst-case, base-case, or alternative-case scenarios. You also need to define the scope and time horizon of your analysis, and the level of detail and accuracy you require.

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Abhinaya Sundara Raman

Experienced Fund Accountant | Project Cost Coordinator | Investment Banker | Passionate about Enhancing Financial Accuracy for Clients | Ex-BNP | Ex-SBS
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To plan for the future, you need to identify the key variables that impact its success, such as market conditions, economic indicators, and internal factors. These allow to construct scenarios, explore challenges and opportunities, and make informed decisions. By considering these variables carefully, we can create scenarios that accurately reflect the business's situation.

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2 Select the variables

The next step is to identify the key variables that affect the outcome of your analysis, and determine how they are related to each other. Variables can be internal or external, quantitative or qualitative, and deterministic or stochastic. For example, some common variables for valuation scenarios are revenue growth, profit margin, discount rate, and exit multiple. You should select the variables that are most relevant and material for your purpose, and avoid including too many or too few variables that may make your analysis too complex or too simplistic.

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Jeetain Kumar, FMVA?

I help students & executive in finance ? 35 Million Views ? 51k ? KPMG Certified Financial Consultant ? ESG & FP&A Specialist
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When conducting scenario analysis, selecting the right variables is paramount. Identify key factors that significantly impact outcomes, considering both internal and external influences. Prioritize variables based on relevance and materiality to your analysis objectives. Strive for a balance between complexity and simplicity, avoiding unnecessary variables that could obscure insights or oversimplify complexities. By carefully selecting variables aligned with your goals, you can enhance the accuracy and usefulness of your scenario analysis, enabling informed decision-making and proactive risk management in dynamic business environments.

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3 Assign the values

Once you have selected the variables, you need to assign values to them for each scenario. You can use historical data, market data, industry benchmarks, expert opinions, or your own assumptions to estimate the values. You should also consider the probability and uncertainty of each value, and use appropriate methods to account for them, such as sensitivity analysis, Monte Carlo simulation, or decision trees. You should also justify and document your assumptions and sources, and check for consistency and validity across scenarios.

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4 Calculate the results

After you have assigned the values, you can use a financial model to calculate the results for each scenario. A financial model is a mathematical representation of the cash flows and value of a company, project, or portfolio, based on the input variables. You can use various software tools, such as Excel, to build and run your model. You should ensure that your model is accurate, reliable, and flexible, and that it can handle different scenarios and inputs easily. You should also test and debug your model, and review the results for reasonableness and sensitivity.

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5 Analyze the implications

The final step is to analyze the implications of the results for your purpose and objectives. You should compare and contrast the different scenarios, and identify the main drivers and risks of the outcome. You should also evaluate the trade-offs and opportunities of each scenario, and assess the impact on the value and performance of the company, project, or portfolio. You should also consider the limitations and assumptions of your analysis, and how they may affect the reliability and validity of your results.

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6 Communicate the findings

The last but not least factor to consider is how to communicate your findings and recommendations to your clients and stakeholders. You should use clear and concise language, and present your results in a logical and coherent way. You should also use appropriate formats and visuals, such as tables, charts, graphs, or dashboards, to illustrate and highlight the key points and insights of your analysis. You should also provide a summary and conclusion, and address any questions or feedback that may arise from your audience.

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Karanjeet Singh, ACA, CFA, MBA

Partner - Investment Banking | Instagram: _karrancy
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This is a point of high importance, as all the analysis is useless if it does not help you to make a good decision in the end. The decision should be supported by the fact that how did the scenario analysis save you money or generated more sales.

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7 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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Matheus de Souza Barboza

Finan?as | E-commerce | Marketplaces | Estratégia | Consultor | Conselheiro | Board Member | C-level | Valuation | CEO | CFO
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Variáveis-Chave: Identificar e compreender as variáveis mais relevantes que influenciam o cenário em quest?o, como condi??es econ?micas, regulatórias, tecnológicas e de mercado. Cenários Alternativos: Desenvolver cenários alternativos que representem diferentes trajetórias possíveis, incluindo cenários otimistas, pessimistas e realistas, para capturar a incerteza inerente ao ambiente. Sensibilidade e Incerteza: Avaliar a sensibilidade das premissas e variáveis-chave em rela??o aos resultados esperados e quantificar a incerteza associada a cada cenário.

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Joy Otuonye

Administrative Executive || Financial Reporting || Treasury and Risk Management || Program Management || Budgeting and Forecasting || Data Analyst.
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When performing scenario analysis, it's essential to: 1. Identify key variables: Identify the critical variables that drive the performance of the investment or project, such as revenue growth, cost structure, interest rates, etc. 2. Create a scenario: Develop a range of plausible scenarios that encompass different potential future states. 3. Define assumptions: Clearly define the assumptions underlying each scenario. 4. Provide data source: Ensure that you have reliable data to support your assumptions and scenario outcomes. 5. Interdependence : Consider how changes in one variable may impact other variables. Identify any correlations or interdependencies between different factors and incorporate them into your analysis.

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Matheus de Souza Barboza

Finan?as | E-commerce | Marketplaces | Estratégia | Consultor | Conselheiro | Board Member | C-level | Valuation | CEO | CFO
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Impacto nas Decis?es: Analisar o impacto de cada cenário nas decis?es estratégicas, financeiras e operacionais da organiza??o, permitindo uma melhor prepara??o para enfrentar diferentes contextos futuros. Atualiza??o Contínua: Manter a análise de cenários atualizada e iterativa, revisando regularmente as premissas e os resultados à medida que novas informa??es e eventos se desdobram, garantindo a relevancia e a precis?o das proje??es.

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What are the most important factors to consider when performing scenario analysis?

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1 Define the purpose

2 Select the variables

3 Assign the values

4 Calculate the results

5 Analyze the implications

6 Communicate the findings

7 Here’s what else to consider

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