Scenario vs. Sensitivity Analysis Differences

Subject: Company Analysis
Pages: 2
Words: 410
Reading time:
2 min
Study level: College

Both types of analysis exist for the purpose of examining potential business scenarios, as well as testing the potential opportunities of investment. However, these two types of analysis are fundamentally different in how the analysis itself is performed. Sensitivity analysis, to start with, involves the effects of changing one factor in a bigger picture and seeing the effects it might bring, both positive and negative. This method usually examines the outcomes and singular changes, to both dependent and independent variables, such as product quantity, pricing, stock, supply, and demand. Factors other than the outcome can also be examined, as a way to compare the viability of investment for potential backers.

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Scenario analysis, on the other hand, seeks to examine an array of factors at the same time, focusing on the effects of multiple changes at a time. The evaluation based on scenario analysis is performed by predicting a number of “scenarios”, ranging from most to least favorable outcome. Base scenario, its best and worst-case variations are all used to create a more full overview of future business opportunities. This method usually takes independent variables into consideration. There are certain advantages to either method, as they can be used in conjunction with each other to achieve a better result. Sensitivity analysis is deeper, while scenario analysis allows a person to conduct a systemic overview of a specific case.

Basically, operating leverage is a term used to describe a company’s fixed costs. Fixed costs are that which need to always be considered, and they remain relatively stable over time. Operating leverage framed them as a percent of the total costs of an organization. This helps to determine the actual profits of an organization, as well as the ability of an organization to earn more than it spends. Leverage can be both high and low, and the benefits of both depend on the company. Companies with high operating leverage have the ability to gain more profit from their products, by the virtue of their costs staying relatively the same. If higher operating leverage can be covered, the company is left with a significant profit in return. Alternatively, the inability to secure such profits leaves a company at a major financial disadvantage. On the other hand, low operating leverage means that a company’s expenses are mostly variable, leaving room for extra expenditure and uncertainty. This means that the overall profit on each sale will be smaller, but less is also spent on covering operations.

References

Overview of sensitivity analysis – what is sensitivity analysis. Corporate Finance Institute. (2020).

DelVecchio, L. (2021). Sensitivity analysis vs scenario analysis: What’s the difference? Planergy Software.