## What is a Sensitivity Analysis - Example and Components involved

SENSITIVITY ANALYSIS

A Sensitivity Analysis is a "what-if" tool that examines the effect on a company's Net Income (bottom line) when sales levels are increased or decreased. For example, the sensitivity analysis can answer the following questions:

• "WHAT" would be my forecasted net income, "IF" my sales forecast is 30%, 20%, or 10% too high?
• "WHAT" would be my forecasted net income, "IF" my sales forecast is 30%, 20% or 10% too low?

In other words;

1.  What would my bottom line be if I sold 10% more units than I originally forecasted?

2.  What would my bottom line be if I sold 20% more units than I originally forecasted?

3.  What would my bottom line be if I sold 30% more units than I originally forecasted?

4.  What would my bottom line be if I sold 10% fewer units than I originally forecasted?

5.  What would my bottom line be if I sold 20% fewer units than I originally forecasted?

6.  What would my bottom line be if I sold 30% fewer units than I originally forecasted?

Below provides an example of a sensitivity analysis.

 RESUME SERVICES FORECASTED SENSITIVITY ANALYSIS FOR YEAR ENDING DECEMBER 31, 200X 15% Decline in Sales 10% Decline in Sales 200X Original Forecasted Figures 10% Incline in Sales Sales \$88,400 \$93,600 \$104,000 \$114,400 Cost of Goods Sold \$10,200 \$10,800 \$ 12,000 \$ 13,200 GROSS PROFIT \$78,200 \$82,800 \$ 92,000 \$101,200 OPERATING EXPENSES: Marketing Expenses: Promotional Pamphlet Expense \$ 4,000 \$4,000 \$4,000 \$ 4,000 University Advertising Expense \$ 8,000 \$8,000 \$8,000 \$ 8,000 Newspaper Advertising Expense \$25,998 \$25,998 \$25,998 \$25,998 Total Marketing Expenses \$37,998 \$37,998 \$37,998 \$37,998 Administrative Expenses: Office Salaries Expense \$15,600 \$15,600 \$15,600 \$15,600 Employer Costs (11% of Salary) \$1,716 \$1,716 \$1,716 \$1,716 Office Supplies Expense \$2,500 \$2,500 \$2,500 \$2,500 Business Cards, etc. Expense \$ 250 \$ 250 \$ 250 \$ 250 Printing of Checks Expense \$ 75 \$ 75 \$ 75 \$ 75 Telephone Expense \$1,200 \$1,200 \$1,200 \$1,200 Business Registration Expense \$1,200 \$1,200 \$1,200 \$1,200 Message Centre Expense \$4,600 \$4,600 \$4,600 \$4,600 Toll Free Services Expense \$9,600 \$9,600 \$9,600 \$9,600 Credit Card Service Expense \$4,992 \$4,992 \$4,992 \$4,922 Bank Charges Expense \$ 240 \$ 240 \$ 240 \$ 240 Miscellaneous Expenses \$1,800 \$1,800 \$1,800 \$1,800 Depreciation Expense, Auto \$1,000 \$1,000 \$1,000 \$1,000 Depreciation Expense, Equipment \$1,400 \$1,400 \$1,400 \$1,400 Total Administrative Expenses \$46,173 \$46,173 \$46,173 \$46,173 TOTAL OPERATING EXPENSES \$84,171 \$84,171 \$84,171 \$84,171 INCOME BEFORE TAXES \$(5,971) \$(1,371) \$7,829 \$17,029

A sensitivity analysis consists of three main components namely; 1) The Heading, 2) Sales Percentage Factors, and 3) The Body.  Below briefly explains each component; beginning with The Heading.

STEPS TO DEVELOP A SENSITIVITY ANALYSIS ARE SUMMARIZED BELOW:

• develop your forecasted income statement;
• set your sales percentage factors (10%, 20%, and 30% for instance); look at each cost & expense and determine which is a variable cost and which is a fixed cost;
• Increase & decrease the sales in dollars at the various sales percentage (%) factors;
• Increase & decrease the variable costs at the various sales percentage (%) factors;
• The fixed costs will remain the same at various sales increases & decreases;
• Subtract each column's variable costs and fixed costs from each sales column to arrive at the net income before tax at the various sales increases & decreases;
• Apply a tax rate to the net income before taxes to arrive at the Net Income After Taxes (optional).

Don't get frustrated when distinguishing between a variable cost and a fixed costs. All you have to do is ask yourself - "will this cost or expense increase or decrease if I sell one additional unit or sell one fewer unit?" If the answer is yes, then it's a variable cost AND if the answer is no, then it's a fixed cost.

The following link provides a complete Sensitivity Analysis example (highly recommended read).  In addition, below provides two more sensitivity analysis examples.

EXAMPLES OF A SENSITIVITY ANALYSIS:

Categories: Financial