Principles of Financial Modelling

CHAPTER 4Defining Sensitivity and Flexibility Requirements

INTRODUCTION

This chapter discusses what is perhaps the single most important area to consider when planning and designing models. This concerns ensuring that one clearly defines (early in the processes) the nature of the sensitivity analysis that will be used in decision support, and using this as the fundamental driver in model design. As in the author's earlier work Financial Modelling in Practice, we use the term “sensitivity-analysis thinking” (“SAT”) to describe this, and to emphasise the conceptual nature of this approach to model design (and to contrast it with quantitative sensitivity analysis that may be used later in the process).

In fact, a generalisation of the SAT concept is that in which the focus is on the “flexibility requirements” of the model. This covers functionality beyond standard sensitivities, such as the ability to update a forecasting model with realised figures as they occur, or the facility to be able to introduce new data or data sets without having to perform undue structural modifications.

In the subsequent text, we will still use the term “SAT” to refer to this general concept of “flexibility and sensitivity thinking”. This chapter focuses on a discussion of the (generalised) SAT concept, whilst Chapter 5 and Chapter 6 discuss design issues relating to model flexibility, especially those which are linked to the design of the data sets and the workbook and worksheet structures.

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