Clients and managing directors like to see a range of possible outcomes, and this is where the sensitivity analysis, or “what-if” analysis comes into play.Īnd Wall Street Prep Private Equity Certificate Program The purpose of the financial model is to provide some insight into future performance, but there is no one correct answer. So what can you do if the financial model’s results are not the final results? Isn’t that why you build a model in the first place - to get some clarity or answer as to the future performance of the business? Yes and no. Because the future cannot be predicted with any certainty, it’s never a good idea to take your financial model’s results and claim, either to your boss or to your client, that the results are final. This allows the analyst to “stress-test” the financial results because the reality is that expectations can and often do change over time. In previous articles, we discussed the fact that these forward-looking assumptions may not always hold true, and that the use of a scenario manager is a great way to incorporate several performance possibilities into your financial model.

General Rule of Thumb in Sensitivity AnalysisĪ scenario manager allows the analyst to “stress-test” the financial results because the reality is that expectations can and usually do change over time.

Typically, once an analyst inputs both historical financial results and assumptions about future performance, he/she can then calculate and interpret various ratio analyses, and other operational performance metrics such as profit margins, inventory turnover, cash collections, leverage and interest coverage ratios, among others. It provides a way for the analyst to organize a business’s operations and analyze the results in both a “time-series” format (measuring the company’s performance against itself over time) and a “cross-sectional” format (measuring the company’s performance against industry peers). Sensitivity Analysis (“What if” Analysis)Ī financial model is a great way to assess the performance of a business on both a historical and projected basis.

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