sensitivity analysis
A technique testing how different values of a key variable affect a particular outcome in a financial model, showing which assumptions matter most.
Example
“The sensitivity analysis showed the project's NPV was highly sensitive to the discount rate but barely affected by revenue growth assumptions.”
Memory Tip
SENSITIVITY ANALYSIS = change one variable, see how the output changes. Find the critical assumptions.
Why It Matters
Sensitivity analysis helps you understand which financial assumptions have the biggest impact on your outcomes, allowing you to focus your attention and planning efforts on the variables that truly matter. This is especially valuable when making major decisions like buying a home or investing, where small changes in interest rates or market conditions could significantly alter your financial results.
Common Misconception
Many people believe sensitivity analysis predicts the future or tells you what will definitely happen, when in reality it only shows how different scenarios would play out if certain assumptions change. It is a planning tool that explores possibilities, not a crystal ball that reveals what will actually occur.
In Practice
Suppose you are considering a 30-year mortgage for a house and want to understand how interest rate changes affect your monthly payment. A sensitivity analysis might show that at 3 percent interest your payment is 1265 dollars per month, at 4 percent it becomes 1432 dollars, and at 5 percent it reaches 1610 dollars. This reveals that a 2 percent rate increase creates a 345 dollar monthly difference, helping you decide whether to lock in a rate now or wait for potentially better terms.
Etymology
SENSITIVITY (how responsive to change) ANALYSIS. Analyzing how SENSITIVE results are to changing assumptions.
Common Misspellings
Small business accounting made simple
Related Terms
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See Also
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