Short definition: Scenario analysis is a financial modeling technique that involves evaluating the potential outcomes of a decision or plan under different sets of assumptions or conditions.
Explanation: Scenario analysis helps to assess the potential impact of different future events on a company’s financial performance, identify potential risks and opportunities, and develop contingency plans. It involves creating multiple scenarios, each with its own set of assumptions about key variables such as market conditions, interest rates, and economic growth.
Example: A company might conduct a scenario analysis to assess the impact of different economic scenarios (e.g., recession, moderate growth, strong growth) on its sales, profits, and cash flows.
Additional information (optional): Scenario analysis can be used in various contexts, such as investment analysis, risk management, strategic planning, and project evaluation. It is a valuable tool for decision-makers as it provides insights into the potential range of outcomes and helps them to make more informed decisions.