Scenario Analysis vs. Sensitivity Analysis

Life – as well as running a business – is full of uncertainty. That said, there are various methods you can use to assess risk in order to keep an organization on track to attaining its financial goals, despite unexpected obstacles. Risks to your business can be external economic or political factors, or more company-specific, relating to internal operational issues.  Scenario analysis and sensitivity analysis are two common methods of quantitative risk analysis used in financial modeling. These methods look at the key drivers of an organization and investigate the financial impact of potential changes on the business, both negative and positive. They can help finance professionals create a forward-looking view of risks and opportunities facing their company.

Scenario analysis involves investigating potential future situations and predicting the possible outcomes (or scenarios) of important business decisions based on different variables and assumptions. Financial experts often use scenario analysis to help them determine the value of a future investment and its effect to their cashflow. When performing scenario analysis, financial modelers will typically start with at least three alternative scenarios: base-case (no major changes from the present), best-case (the most optimistic outcome) and worst-case (the most pessimistic outcome). It is important to keep in mind that these scenarios are not intended to act as predictions, but rather represent hypothetical constructs to guide decision-making.

Some common uses for scenario analysis are:

• Planning for future investments – projecting gains or losses
• Being prepared for unexpected and uncontrollable events
• Optimizing the distribution of organizational resources

In contrast, sensitivity analysis is a method of financial modeling used to determine the impact of one independent variable on a specific dependent variable under a given set of assumptions. For example, this method could be used if a company wanted to discover how high it could raise the price of a product before customers stop buying and opt for a competitor. This can also be referred to as “what-if” analysis, (What if we did this? What if we did that?) used to investigate how sensitive a financial model’s outputs are to various changes in inputs, and how this level of sensitivity might affect strategies and decisions. Sensitivity analysis is a great tool for financial professionals to prioritize which variables are more critical than others when influencing a particular outcome.

The major difference between these two methods is that sensitivity analysis examines one variable at a time, while scenario analysis investigates the effects of changing all the variables at the same time. The advantage of a sensitivity analysis is that it can use historical data to provide an in-depth evaluation of one specific variable and can produce a range of values to provide an accurate financial picture. In comparison, by forecasting future events, scenario analysis can be very useful to visualize multiple outcomes that may result from a new strategy or decision.

So – the question is – which one should you use? Rather – why should you have to choose just one? Using both methods of analysis together will provide the most accurate and comprehensive view of your organization’s financial future and the options you have available throughout changing circumstances. By seeking all the possible outcomes of the project or venture that you are modeling, you can gain a real in-depth understanding of the key drivers of your business and how they can be influenced by the ups and downs that life is sure to bring. For example, by using both methods you can easily assess what the outcomes would be if you decided to pursue a new investment opportunity while raising the price of your product. 

It's never a good idea to make a decision in a vacuum – when you are making important business decisions that will affect the future trajectory of your organization, it is imperative to be well-informed and consider multiple perspectives and variables. The question then becomes, how do you incorporate both scenario and sensitivity analyses into your risk assessment protocol? Doing this using traditional spreadsheets is extremely time consuming, preventing your team from focusing on other important tasks.  You need a platform that is capable of testing an unlimited number of assumptions at once, in real time, all within a single financial model. Synario is purposefully designed to perform both scenario and sensitivity analyses, accurately and efficiently, without all the headaches of spreadsheets. 

Synario's patented Multiverse Modeling™ technology allows users to explore an unlimited number of financial scenarios from a single model. Synario does modeling and analysis best. Easily zoom in on the effects of individual financial variables on your organizations financial outlook. Through user-friendly sliders and interactive charts and graphs, Synario removes the difficulties surrounding sensitivity testing in a spreadsheet.

Want to learn more about how to master both scenario and sensitivity analysis? Contact us, and we’ll help you build a financial model that empowers your team and transforms your organization.