A huge part of financial planning is evaluating potential scenarios your business is going to face in the future. There is a number of ways you can do that, scenario planning, sensitivity analysis and what-if analysis.
What is what-if analysis?
What-if analysis has many names in financial modeling world – some refer to it as sensitivity analysis, other as contingency analysis. But truth be told, the difference is incredibly minor. So, what is what-if analysis?
What-If analysis is a process that concentrates on looking at what happens when a business takes a certain action or is impacted in some way by tweaking one key input or driver in a financial model and seeing how the model reacts.
Based on the possible situations that come out of the results, the company can make an informed decision about what action the business will require in said situation. The primary goal of what-if analysis is to include many solutions in the decision and not limit your business resources too much.
What-if analysis vs scenario planning?
Contingency planning is a what-if tool that looks into one uncertainty only, while scenario planning considers combinations of uncertainties in each scenario. Also, scenario planning takes much wider combinations of uncertainties that include social and economic developments.
Scenario planning is also much more qualitative, while plenty of programmes are available to help form the simulations, it is still less formalized.
What if analysis looks into single uncertainty with greater depth, also it is more likely to look at internal business uncertainties, such as “what if sales go by x, but employees drop by y”.
What-if scenario planning…
These two terms are commonly used together, but it hasn’t always been like that. As we mentioned, typically scenario planning can be a very qualitative process which isn’t always in the best interest of the business.
Recently more and more people refer to scenario planning and what-if analysis as the same process, because more and more scenarios are based on quantitative data from what-if analysis that will contribute to large parts of certain scenarios.
The aim of what-if planning is to improve decision making and reduce potential business risk and therefore have a positive impact on the bottom line of the business.
So if you haven’t started running what-if analysis yet, now is the time! You will be putting your company on the road to success and it will give you a leg ahead of your competition.