Are you piecing together a corporate budget? What are the main factors that can sway your financial results? Although many corporate budgets rely on historical information, budgets do need to be adjusted based on upcoming risks and operational changes.
This is where a sensitivity analysis comes into play, helping your team determine which factors will have an influential impact on your financial goals. In this article, we’ll cover ten key assumptions to test for in a corporate budget sensitivity analysis.
If you are confused about how to start piecing your sensitivity analysis together, check out our CPE-eligible Budgeting Bootcamp.
Sales Levels
One of the fundamental components included in a corporate budget is sales levels. Do you expect an increase in sales or a decrease? In many cases, your sales levels will impact other areas of your budget, such as variable costs. Start by looking at historical information. Have sales been trending up? Then, input different numbers into your sensitivity analysis. How do changing sales levels impact profitability? Answering this question allows you to better plan resources.
Variable Costs
Another key assumption in corporate budgeting sensitivity analysis is variable costs. Variable costs are expenses that change with production levels. For example, variable costs might include raw materials and direct labor if your business is a producer of goods or services. Although variable costs are heavily dependent on your sales levels, it’s important to test the sensitivity of price changes in this category. What happens if your main supplier increases prices by 10%? How about if you have high employee turnover? Digging into variable cost changes infuses transparency into your profit margins and helps you make more informed decisions.
Fixed Costs
Just like variable costs are important in your corporate budget, so are fixed costs. Fixed costs are expenses that don’t normally change from month-to-month. For example, if you have a year-long lease, you can expect the same rent expense each month. When it comes to building your sensitivity analysis for fixed costs, evaluating your agreements is a good starting point. When does your insurance policy expire? What about leases and notes payable? Testing the sensitivity of price changes in these categories is crucial to building a robust corporate budget.
Fixed Asset Purchases
Fixed asset purchases are capital intensive, meaning they need to be factored into your corporate budget. What expenses are on the horizon? This could be replacing the roof in your warehouse, upgrading your server, or purchasing a new vehicle. What will the impact be on your cash flow and profitability if you make these purchases in the next budgetary period? Do you need more time to save up or should you look for financing to preserve cash flow? These are all questions that can be answered with detailed sensitivity analysis.
Customer Demand
Customer demand is an integral component of creating an accurate budget, especially if your business is seasonal. For example, if your business is in the real estate industry, there is an influx of properties on the market from late spring to early summer. This means that your capital budget during these months will be drastically different from the winter months. Forecasting customer demand helps you plan your sales levels and gives you insight into how to effectively allocate resources.
Legislation Changes
An overlooked assumption in corporate budgeting sensitivity analysis is legislative changes. What happens if the tax rate increases? How about if one of your main deductions is disallowed? One of the main goals of corporate budgeting is to properly allocate resources. If your tax bill is going to double due to legislative changes, you need to be aware of the impact on your checking account and start planning. Sensitivity analysis evaluates the likelihood of certain legislative changes occurring, helping you identify and protect against the top risks in your organization.
Variable Debt Repayment
Variable debt repayment is another component to test in a sensitivity analysis. Variable debt can include hard money loans and lines of credit. What are the results of financing a new real estate property at 5% versus 7%? How would your line of credit interest rate jumping up 3% affect your cash flow? Corporate budgeting relies on understanding the likely debt repayment amount, which is why it’s an important component to evaluate through sensitivity analysis.
Dividends and Distributions
Shareholders expect dividends and distributions. Depending on your organization’s structure, you may need to factor in dividends and distributions when creating your corporate budget. For companies that distribute a fixed percentage of profit, you should run a sensitivity analysis to generate transparency in expected payments. Will you be able to pay the required dividends if profitability is cut in half? Do you have the cash available? These are questions that can be answered with an in-depth sensitivity analysis.
Cash Flow
Maintaining effective cash flow management is one of the primary goals of corporate budgeting. Having cash available to pay employees and vendors timely is critical for every organization, regardless of your industry. Building a cash flow sensitivity analysis identifies vulnerabilities and helps you better prepare for uncertainties. For example, you might look into the impact of 10% of your customers defaulting on their invoices or the cost-savings from leveraging early payment discounts.
Salaries and Wages
Salaries and wages should also be revisited when creating your corporate budget. As employee demands continue to shift, you need to understand the risks and rewards of changing your compensation structure. How would a company-wide 10% raise affect your margins? Would productivity and sales decrease if you implemented a hybrid work schedule? Part of employee retention is offering competitive wages, which can be done without draining your bank account when you know what’s in store and can make data-driven decisions.
Summary
These ten assumptions should be tested through sensitivity analysis during the corporate budget building process. After all, the more insights you can develop surrounding risks, expectations, and the future, the better you can plan resources and work toward your strategic goals.
