Scenario Analysis
IntermediateScenario analysis is a planning method that estimates how financial results would change under several different possible futures, such as a base case, an optimistic case and a pessimistic case.
The future is uncertain, and a single forecast can give a false sense of certainty. Scenario analysis builds a few coherent stories about how the future might unfold and works out the financial results for each.
Each scenario changes several assumptions together in a way that makes sense. A pessimistic scenario might combine lower sales, falling prices and higher costs, reflecting a recession. An optimistic scenario might combine strong demand, higher prices and a successful product launch.
For example, a company might forecast profit of 5 million in its base case, 8 million in its best case and a loss of 1 million in its worst case. Seeing this range helps managers decide whether a plan is acceptable even if things go badly, and what actions to prepare in case they do.
Scenario analysis differs from sensitivity analysis, which changes one assumption at a time to see its individual effect. The two are often used together to understand risk.
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