What is a Sensitivity Analysis - Example and Components involved

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 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.

1.    The Heading
2.    Sales Percentage Factors
3.    The Body


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:

J&B Incorporated
Scholarship Information Services

Categories: Financial