What is sensitivity analysis and how can it help your business?
What is sensitivity analysis in accounting?
Sensitivity analysis involves using a forecast to predict how a change in key variables will affect the performance of your business.
Whilst a standard forecast is used to predict the most likely financial outcome for your business for a set period, say 12 months, sensitivity analysis can be used to plan for uncertainties.
What can a sensitivity analysis be used for?
This can be used to forecast the impact of:
- price changes
- hiring new employees
- cost changes such as to fuel or energy
- investment in new machinery
These are just examples and it can ultimately be used to forecast a change in any financial variable for your business.
Why use sensitivity analysis?
All businesses have seen the impact of unknown variables over the past 18 months. Changes in demand and supply, increases in fuel and energy costs, the loss or need for new employees; the changes for many businesses have been dramatic.
Whilst no-one could have predicted the world events, the use of forecasting and sensitivity analysis would have helped many business owners respond to the impact of these events, and be in a better position to make key decisions for the benefit of their business.
How do you calculate sensitivity in accounting?
Using your bookkeeping software, you can take the profit and loss and cash flow statement for the past 12 months as your starting point of your forecast.
Once you have used this to produce a base forecast, you can review what you think are likely to be the key variables for your business, be it crop prices, energy costs, fuel, fertiliser etc. and then produce multiple scenarios.
These reports can then be used to make changes on your pricing, identifying areas to cut costs, increasing the amount put aside for tax bills, and many other business decisions to ensure you are more confident about how your business will perform in the coming months and years.