Building a business and making it profitable is a hefty task, and a lot of factors can influence how successful a company is. Considering that 18% of small businesses fail in the first year and 65% within 10 years, the decisions that company leaders make are vital to success as the business grows.
Executives have to consider the impact of a variety of influences on their company, such as the cost of materials, market changes and sales. One way to determine how internal and external factors will impact the company is to use a sensitivity analysis. A sensitivity analysis can help prepare a strategy for clients to deal with the effects of fluctuations in a business’ profitability by determining project risk, assessing investment value, and analyzing profit potential.
Sensitivity analysis allows companies to predict the possible outcomes of various scenarios using a mathematical model. In the sensitivity analysis model, an independent variable (or input variable) is inserted into an equation to find the effect on the dependent variable (or target variable). Using historical financial data, the company can make educated decisions based on the information the sensitivity analysis provides.
Determining project risk
Every new project a company undertakes has a certain amount of risk involved. A sensitivity analysis can determine whether a project is worth the risk involved, especially if the project does not go according to plan. A project may be proposed with an estimated budget, completion time, and value that it will bring to the company — and a sensitivity analysis can analyze whether the project is still viable if those variables change. If the project takes longer than expected or costs more money than budgeted, managers may decide it is still profitable enough to go forward, or it could be rejected.
Investment value and profit potential
In business, you have to spend money to make money. But just how effective is your spending? Using sensitivity analysis allows a company to assess the return on investment for specific advertising campaigns, perhaps looking at how the campaign impacted customer acquisition. The analysis could also help determine whether investing in hiring more employees resulted in higher production or sales.
Sensitivity analysis is also a great way to determine what has worked for the company and how to maximize that success. This analysis can look at past sales and determine how they were impacted by different variables, such as foot traffic or price increases. The model can also look at overall profits and ascertain how the profits were affected by price increases, lower production costs or a new material. The sensitivity analysis can show how profits or sales could be increased in the future by these variables.
Company leaders need to make informed decisions to drive their business forward. Sensitivity analysis using historical data gives executives the ability to understand how different variables can make the business successful.