Lesson 7 of 7 · All lessons in this module
- What to forecast: forecast objects and principles
- Forecast approaches and the forecast horizon
- Forecasting revenue: top-down, bottom-up and non-recurring items
- Forecasting operating costs: COGS, SG&A and segment margins
- Working capital, capital investments and capital structure
- Integrated case: fixed assets class by class and a marketplace cost base
- Scenario analysis: risk factors, cost structure and sensitivityVideo lesson
Lesson 7 of 7 · 15 min
Scenario analysis: risk factors, cost structure and sensitivity
Instead of a single point forecast, the analyst builds scenarios around the key risk factors, carries each through revenue and a fixed/variable cost structure to EPS, and tests how sensitive the result is to the most uncertain assumptions.
In short
- Four generic risk factors affect all companies to different degrees: business cycle, competition, inflation/deflation and technological developments.
- Build several scenarios (e.g. bull, base, bear), judge their likelihood, and compare them with other analysts' forecasts and with what the current valuation implies.
- Technology can shift supply right (lower costs) or demand left (attractive substitutes). In a highly competitive industry, cost savings are usually passed on through lower prices.
- Estimate the fixed/variable split: %Δ(total costs) ÷ %Δrevenue ≈ variable share; or assign a fixed % to each cost line and weight them.
- High fixed costs mean operating leverage: lost revenue cuts operating income and margins more than proportionally. A sensitivity table shows results across a grid of assumptions.
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