Financial Forecasting, Analysis and Modelling: A Framework for Long-Term Forecasting

CHAPTER 6

Using Sensitivity Analysis

Chapter 6 examines the use of sensitivity analysis in apportioning the uncertainty of a model's output to the different sources of uncertainty concerning its inputs. Sensitivity analysis is one of the most important tools in financial analysis. It allows a modeller to quickly modify inputs to see how specific key performance indicators of interest will react. This chapter focuses on a quick and painless way to run multiple scenarios without having to change inputs manually each time by making use of Excel data tables. Step-by-step examples walk the reader through the preparation of sensitivity analysis tables. In addition the chapter explains the use of Excel's Goal Seek function and presents through examples the preparation of Tornado charts, as a means of assessing the importance of various model input variables.

6.1 INTRODUCTION

The second part of the book deals with how to introduce uncertainty into our financial forecasting models. As we have seen in the first part, a financial model is used to assess a company's performance on both a historical and a projected basis. It provides a way for the analyst to organize the company's operations and analyze its results. Nevertheless the parameter values and assumptions of any financial model are subject to change and error. In this particular chapter we will focus on sensitivity analysis as a means of investigating these potential changes and errors and their impacts on the conclusions to be ...