So what is what-if analysis? Also defined as sensitivity analysis, what-if analysis is a brainstorming technique used to determine how projected performance is affected by changes in the assumptions that those projections are based upon. What if analysis is often used to compare different scenarios and their potential outcomes based on changing conditions.
Often used scientific research and in conjunction with business and financial risk assessments, sensitivity analysis is applicable to virtually any activity or system. For example, if you're planning a family vacation, you might consider the cost of driving versus flying. However, what if the cost of gasoline goes up between now and then? What if competition heats up between airlines? These factors could affect your costs and your ultimate decision. By using sensitivity analysis, you can explore various scenarios and make better decisions as a result.
The Benefits of What-if Analysis
Conducting a what-if framework is beneficial in several ways. Not only can you make better and more informed decisions by changing assumptions and observing or estimating the results, you are also better able to predict the outcome of your decisions. For example, if you have conducted a sensitivity analysis before deciding to increase your prices, your decision is less risky than if you didn't go through this exercise. After all, you've already determined how the price increase will affect your business. In addition to providing you with a glimpse into the future, sensitivity analysis leads to faster decisions.
Common What-if Analysis Methods
Common methods of sensitivity analysis include using:
- Scenario management tools such as those built into Microsoft Excel
- Brainstorming techniques involving identifying activities and potential factors that could affect the outcome of those activities. This also involves generating "what if" questions to determine how the activity will be affected by different scenarios.
- Modeling and simulation techniques (often used for testing computer systems and IT scenarios)
Using Sensitivity Analysis in a Business Plan
While sensitivity analysis is often used by researchers, analysts, scientists, and investors, it also makes sense for start-up entrepreneurs and small business managers. After all, starting and managing a new business involves uncertainty and risk. By asking what-if questions and running a financial simulation, you can make better decisions as well as demonstrate the strength of your business plan to investors.
As you learn more about what-if analysis, you may be intimidated by the numerous methods and complex formulas often used. Fortunately, you don't need to dust off your algebra books in order to use sensitivity analysis in your business plan – if you choose the right business planning software.
Look for software application that has what-if functionality built in. Business planning software typically walks you through the process, prompting you to answer questions and fill in the blanks. With a built-in "what if" modeling tool, you can ask your own questions and address the risks and uncertainty surrounding your start-up. These are powerful tools that can help you make better decisions, prove your company's viability under various scenarios, answer questions bankers and investors may have, and guide you toward creating the strongest business possible. What if you could see into the future? How would it affect your decisions?
Or, you could create a business plan that addresses a wide range of likely scenarios? You can. What-if analysis comes built into some of the best business and strategic planning software on the market. Make a smart decision now by choosing strategic planning solution with this vital tool built into it and make even smarter decisions in the future.
About the author
Armin Laidre is a co-founder of ExitAdviser — a cloud-based FSBO platform to selling a small business.