Sensitivity analysis

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Its importance on financial estimates

 

     Have you been already involved in economics and finances for project banking/sponsorship presentation ? Beside classical reports, sensitivity analysis is too frequently missing and should however capt your attention. It appears indeed particularly relevant as it shows changes in results according fluctuation in key parameters on which a project is supposed to become reality.

     Looking at a bank lending, a project should demonstrate its viability in spite of a small increase in investment cost or a slight decrease in selling goods. Its so true that many institutions requires such informative table showing variation importance for approving lending.                                                

     In the above table (example: an aquacultural master plan), you are able to judge, rather quickly, what a variation of 10 or 20% in cost and benefit can cause on financial or economic internal rate of return (IRR). If tiny changes may produce larger results, you can opt for smaller variations as low as 5% or even less. Anyway, such presentation gives a brief overview on changes in estimating your project after a period of time (development with living costs and/or prices going up or down ...for some unpredictable circumstances).

     In the present case, you can observe that the middle case, it means when you have no in/decrease in cost and benefit (as planned) the IRR is 0,31, meaning that there is 31% benefit for a 100% investment. However, there is a huge difference of IRR at extreme values: with -20% cost and +20% benefit, your IRR goes up to 0,434 (43,4%); on the other hand, if there is +20% cost and at the same time -20% benefit, the IRR falls as low as at 0,186 (18,6%) ! Thus, results may fluctuate along a 2,33-fold (1 to 4) within turnover ! This means that results depend highly from real development, i.e. with parameters at that precise time.

     Such analysis shows you that if cost for establishing your business is going up, return on investment will go down. If you sell your product at a lower price, return on investment will go down too.

     However, if production cost is cheaper than projection or if sale of goods (market price per unit) is going up, you will be richer !

     So, you fully realize now that investment should at least operate during stable time (no inflation) or when there is a strong demand ...allowing better price (if supply by others is inexistent).

     As technical partner, economical adviser, financial consultant or working for banking institutions, this was repeatedly asked for giving a final touch on project feasibility relevance ! Really, the F/EIRR shows the risk taken by the proposed project to convince for approval.

     So next time, do not forget to include this important table for influencing positively (bank) decision-makers ...and get your loan !

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