Sensitivity analysis

Definition

Sensitivity analysis examines how the variation in input variables affects outcomes in a financial model. It helps identify which variables have the most significant impact on cash flow and growth projections.

5 Must Know Facts For Your Next Test

1. Sensitivity analysis helps in understanding how changes in key assumptions affect financial forecasts.
2. It is commonly used to assess the risk and uncertainty in financial models by testing different scenarios.
3. The analysis can reveal which variables are most critical to achieving desired financial outcomes.
4. It aids decision-makers in preparing for unfavorable conditions by highlighting potential vulnerabilities.
5. Sensitivity analysis often involves changing one variable at a time while keeping others constant to isolate effects.

Review Questions

• What is the primary purpose of sensitivity analysis in financial forecasting?
• How does sensitivity analysis help in assessing risk and uncertainty?
• Why is it important to identify critical variables through sensitivity analysis?

Related terms

Scenario Analysis: Examines the effects of different future events by considering multiple possible outcomes.

Forecasting: The process of making predictions about future financial performance based on historical data and trends.

Break-even Analysis: Determines the point at which revenues equal costs, indicating no net loss or gain.