Introducing Sensitivity Analysis and What IF Tables in Excel

What is this exercise? This is a set of worksheet that build up the procedure for developing a 1 way sensitivity analysis or a 1 way What IF table. This means that we will be varying 1 variable and noting the effect of its variation on one (or more) output results. What is the Formulation? The formulation is a simple Income Statement. It shows the gross sales reduced by a few costs, then proceeds to calculate some profits and margins. The formulation aims at producing a budget using estimates for such figures as Sales Growth, the growth in Cost of Goods Sold and the growth in Operational Costs. We will start with the Sales Growth and examine its effects on the Profit Margin. By Akram Najjar www.lockergnome.com/nexus/akramnajjar

Click Buttons to go to a specific Works

Buttons to go to a specific Worksheet . . .

Step 1: Setup the Formulation

Factors used in Estimating the 2007 Budget
Sales Growth Growth in Cost of Goods Increase in Operating Expenses 4.00% 5.00% 6.00% 2006 2007 Actual Budgeted 45,000 46,800 (20,000) (21,000) (2,500) (2,600) (3,000) (3,120) 19,500 20,080 (15,000) (15,900) 4,500 4,180 10.00% 8.93% Cell C10 shows the Gross Sales of 2006 + the Sales Growth using Cell B4 Cell C11 shows the Cost of Goods Sold of 2006 + the Growth in COGS using Cell B5 Discounts in C12 are not estimated using a factor. The ratio of Discounts to Gross Sales is computed for 2006 and applied to the projected Gross Sales in 2007 to get the 2007 Discounts. Same logic for Commissions in cell C13. Three values used to estimate the 2007 Budget

Gross Sales Less Cost of Goods Sold Less Discounts Less Commissions Gross Profit Less Operating Expenses Net Profit Net Profit Margin

The Output Cell computed from 2007 estimates which are based on the 3 input cells. This is the cell whose sensitivity to 1 input we will be are analyzing.

Cell C15 shows the Operating Expenses to which we add the increase in Operating Costs using Cell B6.

Gross Sales of 2006 sing Cell B4

Cost of Goods Sold (COGS) in COGS using Cell B5

e not estimated using a factor. s to Gross Sales is computed to the projected Gross Sales in in cell C13.

Operating Expenses of 2006 ncrease in Operating Costs

Step 2: Select the Variables

Factors used in Estimating the 2007 Budget
Sales Growth Growth in Cost of Goods Increase in Operating Expenses 4.00% 5.00% 6.00% Let us analyze the Sensitivity for changes in Sales Growth (Cell B4) - we can do the same for the other 2 factors later (B5 and B6)

Gross Sales Less Cost of Goods Sold Less Discounts Less Commissions Gross Profit Less Operating Expenses Net Profit Net Profit Margin

2006 2007 Actual Budgeted 45,000 46,800 (20,000) (21,000) (2,500) (2,600) (3,000) (3,120) 19,500 20,080 (15,000) (15,900) 4,500 4,180 10.00% 8.93%

Cell C10 depends on the Cell B4, the Sales Growth.

Cell C14 computes Gross Profit using Sales. Therefore, it depends on Cell C10 which depends on Cell B4 Cell C17 depends on C16 (Net Profit depends on Gross Sales which depends on the Sales Growth in B4

This is our OUTPUT Cell. We will analyze its sensitivity to changes in the INPUT cell B4 Color Codes: Green Cells: used for input or changing cells. Go as in Traffic Lights. Yellow Cells: used for values given in the formulation as constants. Usually, these values won't change. All other cells are computed from these and the input cells. Blue Cells: are the output cells, our objective, and hence the color of the sky!

the Cell B4, the Sales Growth.

ross Profit using Gross epends on Cell C10 which

Net Profit) which which depends on the

Step 3: Setup the Analysis Table

Factors used in Estimating the 2007 Budget
Sales Growth Growth in Cost of Goods Increase in Operating Expenses 4.00% 5.00% 6.00% 2006 2007 Actual Budgeted 45,000 46,800 (20,000) (21,000) (2,500) (2,600) (3,000) (3,120) 19,500 20,080 (15,000) (15,900) 4,500 4,180 10.00% 8.93% 8.93% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00% Setting Up the Table

Gross Sales Less Cost of Goods Sold Less Discounts Less Commissions Gross Profit Less Operating Expenses Net Profit Net Profit Margin

Step 1: Columns two columns. Step 2: Rows explained later). We also n rows as the range over wh variable varies. In our case vary it from 2% to 12% wit increments, ie, 21 rows. S you need a 22 x 2 table. Step 3: (Cell E8). Step 4: Sales Growth in cells E9 to Step 5: column, enter =C17 (with t This copies the output cell top right hand cell F9. (The same value). Step 6: and format the cells as you

Setting Up the Table Step 1: Columns: Create a table that has two columns. Step 2: Rows: We need a top row (to be explained later). We also need as many rows as the range over which our input variable varies. In our case, we chose to vary it from 2% to 12% with 0.5 increments, ie, 21 rows. So now you know you need a 22 x 2 table. Step 3: Keep the top left hand cell blank. (Cell E8). Step 4: Spread the required values of the Sales Growth in cells E9 to E29. Step 5: In cell F9, the top of our results column, enter =C17 (with the equal sign). This copies the output cell C17 into our top right hand cell F9. (They will have the same value). Step 6: color code the table as shown and format the cells as you wish.

Step 4: Run the Sensitivity Analysis

Factors used in Estimating the 2007 Budget
Sales Growth Growth in Cost of Goods Increase in Operating Expenses 4.00% 5.00% 6.00% 2006 2007 Actual Budgeted 45,000 46,800 (20,000) (21,000) (2,500) (2,600) (3,000) (3,120) 19,500 20,080 (15,000) (15,900) 4,500 4,180 10.00% 8.93% 8.93% 7.39% 7.78% 8.17% 8.55% 8.93% 9.31% 9.68% 10.05% 10.42% 10.78% 11.14% 11.50% 11.85% 12.20% 12.55% 12.89% 13.23% 13.57% 13.90% 14.24% 14.56%

Run the Sensitivity Analy

Gross Sales Less Cost of Goods Sold Less Discounts Less Commissions Gross Profit Less Operating Expenses Net Profit Net Profit Margin

2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00%

Step 1: Step 2: Step 3: get a dialog box like the on Step 4: for this box. a) Since we are running a only need to define one ce b) Since our input variable we need a value in the "Co lower one (highlighted in g c) Since the value our ana we click on the "Column in click in Cell B4. Excel write absolute value here, but w its own). Step 5:

Run the Sensitivity Analysis Step 1: Select the table E8:F29 Step 2: Select the Data menu Step 3: Select the Table entry in the menu. You will get a dialog box like the one shown on the left! Step 4: Excel does not provide a good explanation for this box. a) Since we are running a 1 variable analysis, we only need to define one cell. b) Since our input variable is spread over a column, we need a value in the "Column input cell" field, the lower one (highlighted in green). c) Since the value our analysis depends on cell B4, we click on the "Column input cell" field and then click in Cell B4. Excel writes $B$4. (Excel needs an absolute value here, but we don't care. It will do it on its own). Step 5: Press OK and you have the result.

Step 5: Try it from Scratch

Factors used in Estimating the 2007 Budget
Sales Growth Growth in Cost of Goods Increase in Operating Expenses 4.00% 5.00% 6.00% 2006 2007 Actual Budgeted 45,000 46,800 (20,000) (21,000) (2,500) (2,600) (3,000) (3,120) 19,500 20,080 (15,000) (15,900) 4,500 4,180 10.00% 8.93%

Gross Sales Less Cost of Goods Sold Less Discounts Less Commissions Gross Profit Less Operating Expenses Net Profit Net Profit Margin

Step 6: Multiple Output

Factors used in Estimating the 2007 Budget
Sales Growth Growth in Cost of Goods Increase in Operating Expenses 4.00% 5.00% 6.00% 2006 2007 Actual Budgeted 45,000 46,800 (20,000) (21,000) (2,500) (2,600) (3,000) (3,120) 19,500 20,080 (15,000) (15,900) 4,500 4,180 10.00% 8.93% 8.93% 7.39% 7.78% 8.17% 8.55% 8.93% 9.31% 9.68% 10.05% 10.42% 10.78% 11.14% 11.50% 11.85% 12.20% 12.55% 12.89% 13.23% 13.57% 13.90% 14.24% 14.56% 4,180 3,390 3,587 3,785 3,983 4,180 4,378 4,575 4,773 4,970 5,168 5,365 5,563 5,760 5,958 6,155 6,353 6,550 6,748 6,945 7,143 7,340

Gross Sales Less Cost of Goods Sold Less Discounts Less Commissions Gross Profit Less Operating Expenses Net Profit Net Profit Margin

2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00%

20,080 19,290 19,488 19,685 19,883 20,080 20,278 20,475 20,673 20,870 21,068 21,265 21,463 21,660 21,858 22,055 22,253 22,450 22,648 22,845 23,043 23,240

More than 1 Output Variable We tried a 1 way What IF analysis in the previous example. But we only had 1 output variable. Although we have 1 input only, we can have several output variables. Step 1: Add as many columns as you have output variables. (Here we have a total of 3 output variables). Step 2: At the top of each column, point to the variable you wish to analyze the sensitivity of. We have in F8 to earlier value = C17. In G8, we have =C16, the Net Profit. In H8, we have =C14, the Gross Profit. Now apply the Data/Table procedure in exactly the same way but highlight the whole table (E8:H29).

Step 7: One Variable - Conclusion

Factors used in Estimating the 2007 Budget
Sales Growth Growth in Cost of Goods Increase in Operating Expenses 4.00% 5.00% 6.00% 2006 2007 Actual Budgeted 45,000 46,800 (20,000) (21,000) (2,500) (2,600) (3,000) (3,120) 19,500 20,080 (15,000) (15,900) 4,500 4,180 10.00% 8.93% 8.93% 7.39% 7.78% 8.17% 8.55% 8.93% 9.31% 9.68% 10.05% 10.42% 10.78% 11.14% 11.50% 11.85% 12.20% 12.55% 12.89% 13.23% 13.57% 13.90% 14.24% 14.56% 4,180 3,390 3,587 3,785 3,983 4,180 4,378 4,575 4,773 4,970 5,168 5,365 5,563 5,760 5,958 6,155 6,353 6,550 6,748 6,945 7,143 7,340

Gross Sales Less Cost of Goods Sold Less Discounts Less Commissions Gross Profit Less Operating Expenses Net Profit Net Profit Margin

2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00%

Net Profit vs Sale

8,000 7,000 6,000 Sales Growth 5,000 4,000 3,000 2,000 1,000 0 0.00% 2.00% 4.00%

20,080 19,290 19,488 19,685 19,883 20,080 20,278 20,475 20,673 20,870 21,068 21,265 21,463 21,660 21,858 22,055 22,253 22,450 22,648 22,845 23,043 23,240

Summary: What IF with 1 Input Variable 1) We can only have 1 input variable. We tried all workouts using Sales Growth (B4). We could have tried the other parameters: B5 or B6. Do that. 2) We tried one output then 3 outputs. You can have as many outputs as you want. Enjoy it while it lasts because you cannot have except one output when applying the 2 way What IF analysis (next worksheet). 3) Plot your table to check Sensitivity visually. You will see that in all three cases, there is an almost linear depends of the output on the Sales Growth. (See graph below).

Net Profit vs Sales Growth

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

Net Profit

Step 8: Two Way Analysis

Factors used in Estimating the 2007 Budget
Sales Growth Growth in Cost of Goods Increase in Operating Expenses 4.00% 5.00% 6.00% 2006 2007 Actual Budgeted 45,000 46,800 (20,000) (21,000) (2,500) (2,600) (3,000) (3,120) 19,500 20,080 (15,000) (15,900) 4,500 4,180 10.00% 8.93% 8.93% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00%

Gross Sales Less Cost of Goods Sold Less Discounts Less Commissions Gross Profit Less Operating Expenses Net Profit Net Profit Margin

2.00% 2.50% 8.69% 8.47% 9.08% 8.86% 9.46% 9.24% Run the Sensitivity Analysis 9.84% 9.62% Step 1: in10.00% the top left hand corner, plac 10.21% enter =C17. Now you see why we cann 10.58% 10.37% way analysis: because we only have 1 10.95% 10.74% Step 2: Decide on the variable for the c 11.32% 11.11% spread the first input variable 11.68% 11.47% range from 2% to 12%. 12.03% 11.83% Step 3: Decide on the variable for the r 12.39% 12.18% Cost of Goods Sold. Spread the values 12.74% 12.53% Step 4: Select the table E8:N29 13.09% 12.88% Step 5: Select the Data 13.43% 13.23% Step 6: Select the Table 13.77% shown on 13.57% the left! 14.11% Step 7: 13.91% 14.44% 14.24% a) Since we are running a 2 variable an b) Our first input variable is spread over 14.78% 14.58% input cell" 14.90% field, the lower one (highlight 15.11% cell" field and then click in Cell B4. Exce 15.43% 15.23% c) Our second input variable is spread o 15.75% 15.56% cell", the upper field (highlighted in oran Step 8: Press OK and you have the res

3.00% 3.50% 4.00% 4.50% 5.00% 5.50% 8.26% 8.04% 7.82% 7.60% 7.39% 7.17% 8.64% 8.43% 8.21% 7.99% 7.78% 7.56% 9.03% 8.81% 8.60% 8.38% 8.17% 7.95% the Sensitivity Analysis 9.41% 9.19% 8.98% 8.77% 8.55% 8.34% in the top left hand corner, place the value of the 9.15% output cell as a formula or 9.79% 9.57% 9.36% 8.93% 8.72% =C17. Now you10.16% see why we 9.95% cannot have more than 1 output variable in the 2 9.73% 9.52% 9.31% 9.10% analysis: because we only have 1 corner cell! 10.53% 10.32% 10.11% 9.89% 9.68% 9.47% Decide on the variable for the column. It is the Sales Growth as before. 9.84% So, 10.90% 10.68% 10.47% 10.26% 10.05% ad the first input variable 11.26% 11.05% 10.84% 10.63% 10.42% 10.21% e from 2% to 12%. 11.62% 11.41% 11.20% 10.99% 10.78% 10.57% : Decide on the variable for the row (orange). We will use the Growth in the 11.97% 11.77% 11.56% 11.35% 11.14% 10.93% of Goods Sold. Spread the values from F8 to N8 as 2% to 6%. 12.33% 12.12% 11.91% 11.71% 11.50% 11.29% Select the table E8:N29 12.67% 12.47% 12.26% 12.06% 11.85% 11.65% Select the Data menu 13.02% 12.82% 12.61% 12.41% 12.20% 12.00% Select the Table entry in the menu. You will get a dialog box like the one 13.36% 13.16% 12.96% 12.75% 12.55% 12.34% n on the left! 13.70% 13.50% 13.30% 13.09% 12.89% 12.69% 14.04% 13.84% 13.64% 13.43% 13.23% 13.03% nce we are running a 2 variable analysis, we need to define two cells. ur first input variable is spread over a column, we need a value13.57% in the "Column 14.37% 14.17% 13.97% 13.77% 13.37% cell" field, the lower one (highlighted green ). We click on the "Column input 14.70% 14.50% in 14.30% 14.10% 13.90% 13.70% ield and then click in Cell B4. Excel writes $B$4. 14.43% 15.03% 14.83% 14.63% 14.24% 14.04% ur second input variable over a row, we need a value14.56% in the "Row input 15.36%is spread 15.16% 14.96% 14.76% 14.37% the upper field (highlighted in orange in the captured image on the left side). Press OK and you have the result.

6.00% 6.95% 7.34% 7.73% 8.12% 8.50% 8.88% 9.26% 9.63% 10.00% 10.37% 10.73% 11.09% 11.44% 11.79% 12.14% 12.49% 12.83% 13.17% 13.50% 13.84% 14.17%

Step 9: Analysis of Sensitivity

Years >>> Revenues and Benefits (IN) Costs (OUT) Net Cashflow Yearly Present Value Calculated NPV Discount Rate Excel's IRR Function 1 -17,000 -17,000 15,455 1,046 0.1000 0.0683 2 5,000 5,000 -4,132 3 5,000 5,000 -3,757 4 5,000 5,000 -3,415 5 Total 5,000 20,000 -17,000 5,000 -3,105

1,500

1,000

500

0 1 -500 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

-1,000

0.0500 0.0525 0.0550 0.0575 0.0600 0.0625 0.0650 0.0675 0.0700 0.0725 0.0750 0.0775 0.0800 0.0825 0.0850 0.0875 0.0900 0.0925 0.0950 0.0975 0.1000 0.1025 0.1050 0.1075 0.1100

1,046 -695 -596 -498 -402 -307 -213 -121 -30 60 148 236 322 407 491 573 655 735 815 893 970 1,046 1,121 1,195 1,268 1,340

Sensitivity of Net Present Value to the Discounting Rate The Net Present Value is computed as follows: 1) Place the revenues or benefits in yearly amounts in row 4 2) Place the costs or cash out in yearly amounts in row 5 3) Find the net cash flow for each year in row 6 4) Find the present value of each amount in row 6 and place it in row 7. (Use Excel's PV formula and use the discounting rate in B9 (in the formulation = 10%). 5) Now sum the cells B7:F7 to get the NPV in cell B8. This NPV depends on the discounting rate in B9. Objective of Sensitivity Analysis: to examine how the NPV varies if the discounting rate varies from 5% to 11%. We use the 1 variable What IF analysis as shown. The graph shows that NPV is increasing, starting negative and crossing the 0 value (for NPV) at around 7%.
The Internal Rate of Return (IRR) of a project is defined as the discounting rate at which NPV is zero. Cell B10 shows Excel's automatic computation of IRR and it is the same as what the sensitivity analysis shows.

Why then use Sensitivity Analysis if Excel has an IRR function? 1) Because visually, we can see when the project is feasible and when it is not (below IRR) 2) Because sometimes Excel fails to produce the IRR 3) Because sometimes we can have a project with more than 1 cross which Excel cannot show.