How can you use sensitivity analysis to identify growth opportunities?

1 What is sensitivity analysis?

Sensitivity analysis is a method of testing how changes in one or more input variables affect the output of a financial model, such as net present value (NPV), internal rate of return (IRR), or earnings per share (EPS). For example, you can use sensitivity analysis to see how a change in the discount rate affects the NPV of a project, or how a change in the revenue growth rate affects the EPS of a company. Sensitivity analysis can help you understand the risks and uncertainties involved in your financial projections and evaluate the potential outcomes of different scenarios.

2 How to perform sensitivity analysis?

To perform sensitivity analysis, you need to have a base case scenario, which is your most realistic or expected scenario, and then vary one or more input variables to create alternative scenarios. You can use a spreadsheet software, such as Excel, to create a data table that shows how the output changes as the input variables change. You can also use a chart, such as a tornado chart or a spider chart, to visualize the impact of each input variable on the output. You can then compare the results of the different scenarios and analyze the sensitivity of the output to the input variables.

3 How to use sensitivity analysis to identify growth opportunities?

Sensitivity analysis can help you identify growth opportunities by demonstrating how your financial performance and value can improve under different scenarios. For instance, you can use it to explore the effects of increasing or decreasing sales volume, price, or margin on revenue and profit. Moreover, it can be used to assess the feasibility and attractiveness of investing in a new project, product, or market by comparing the NPV and IRR of different scenarios. Additionally, sensitivity analysis can be used to evaluate the impact of changing your capital structure on your cost of capital and value. Furthermore, it can help estimate the value of a potential acquisition or merger by changing the assumptions about synergies, growth rate, or discount rate. Finally, it can identify the key drivers and assumptions that have the most influence on your financial performance and value so that you can focus on managing them effectively.

4 What are the benefits of sensitivity analysis?

Sensitivity analysis can provide you with several benefits, such as enhancing your understanding of your business and its environment, improving your decision-making process, reducing your risk exposure, and increasing your confidence and credibility. It can reveal the relationships between the input and output variables, provide you with a range of possible outcomes and their probabilities, identify the worst-case and best-case scenarios, and demonstrate that you have considered various scenarios and their implications.

5 What are the limitations of sensitivity analysis?

Sensitivity analysis has some limitations that you should be aware of, such as the quality and reliability of data and assumptions used to perform the analysis. If the data or assumptions are inaccurate, incomplete, or outdated, the results may be misleading or irrelevant. Additionally, ignoring the interdependencies and correlations between input variables can have an effect on the value or behavior of another input variable that may not be captured by the analysis. Furthermore, sensitivity analysis is subjective and biased by your own preferences or expectations; you may choose input variables or scenarios that support your desired outcome instead of the most realistic or likely ones.

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?