What is Sensitivity Analysis in Project Management and its importance

Sensitivity analysis is one of the key terms used in project management. You need to clarify your concept about sensitivity analysis in light of many factors.

Everything you need to know about sensitivity analysis in project management

Project management can be improved a lot if you focus on all aspects. Sensitivity analysis can help you with many things while making a financial decision. It is important to take a detailed account of sensitivity analysis.

What is sensitivity analysis?

Experts define sensitivity analysis as the term in which different values present in the set of independent variables affect a specific dependent variable. The dependent variable is always affected by the independent variables.

If any kind of change occurs in the independent variable, it is obvious that the dependent variable will be directly affected. The set of independent variables affecting a dependent variable is called sensitivity analysis in project management.

How is it useful?

There are many sensitivity analysis uses, and you can determine many things. If you want to predict companies' share prices, you will have to take the help of sensitivity analysis. You can also gauge the effects on the company because of the interest rate.

There is always uncertainty in the market, leading you to make irrational decisions. If you are serving as a finance professional or you are an investment professional, knowing sensitivity analysis will always come to your rescue. Some of the major benefits that you can obtain by understanding sensitivity analysis are:

·   You will be very good at making any company's predictions in the finance industry.

·   If you want to see how dependent variables will get affected by the independent variables, sensitivity analysis is the tool for it.

·   Using sensitivity analysis, you can make a what-if decision based on the knowledge you will gain. It is also called the stimulation analysis or what-if analysis.

Mathematical tool for scientific and financial modeling:

Sensitivity analysis is also called what-if analysis and simulation analysis. It is commonly referred to as a mathematical tool used for scientific and financial modeling. It helps determine if any kind of uncertainty is present in a model and how it will affect the entire model.

Sometimes independent variables can affect the dependent variables, which can be seen specifically by using sensitivity analysis. If you want to test the surety of assumptions you have made or know whether the results will change if you change the assumptions, sensitivity analysis will come to your rescue.

How can you make sensitivity analysis work?

You will need sensitivity analysis to know whether a specific change will affect your entire project and, if yes, at what percentage. Suppose you want to test whether the change in interest rate is going to affect the bond prices or not.

·   You have to come up with a what-if statement. You have to make a question in which you will determine a specific increase in the interest rate, e.g. if you say that the interest rate increased by 5%.

·   Now you should question how bond prices will get affected if the interest rate goes up by 5%. You will then apply the formula with that specific increase and get the answer.

It will show you how your overall project will be affected just by a little change in one variable. If you want to make changes in variables, it is recommended to use sensitivity analysis first. It will give you a proper insight, and you will be able to take a firm decision.

Methods through which you can apply sensitivity

There are different methods to find sensitivity analysis for different projects. You can choose any method best suited for your project and the variable you are testing. Most people prefer two major methods.

1. Direct method

Regarding the direct method, you have to take an assumption model and substitute different numbers into the model. You can replace the growth rate by substituting different numbers.it will provide you with different revenue amounts according to the number you substituted. There is a proper formula for putting substitute numbers in an assumption model. You will get a direct result by using the formula.

2. Indirect method

The indirect method is slightly different than the direct method. You do not change the value of the assumption directly in this method. You have to insert percentage change within the formula. You will also need a formula for this method; however, it differs from the direct method.

How can you conduct a sensitivity analysis for a project?

You can conduct sensitivity analysis for the project step-by-step. It will make things easy for you, and you will be able to conduct sensitivity analysis quite easily.

The first step is to make a list of all the project elements that will create an impact on the net present value (NPV), also called the internal rate of return. You need to take a keen look at all the project elements. Once you make a proper list of all of them, you will have a clear picture.

As a second step, you have to write the analysis for all of the dependencies in the project management. It will help you to know how a certain dependency was affected after you change certain independent variables or project elements.

As the last step, you will be able to determine how each of the dependencies will create an effect on the net present value.

What are the benefits of sensitivity analysis?

There are many benefits of sensitivity analysis. You can avoid a lot of errors by using sensitivity analysis. It will make your project management speedy and error-free. You will be able to determine what's best for your project.

1. Make better decisions

You can make better decisions for your project management when you use sensitivity analysis. It will help you in making a rational decision that you will have no doubts about. You can make the project successful by making better decisions; sensitivity analysis will help you in this regard.

2. Make reliable predictions

When you have proper data achieved by using a formula, you can make reliable predictions. It will affect the entire project, and nothing will stop it from being a complete success. You have to be very thoughtful when you are making predictions for the future of your project. Any small mistake can ruin the entire project. This is why you need sensitivity analysis to make proper predictions.

3. Know where you need an improvement

Once you are done conducting a sensitivity analysis, you will know where your project needs improvement. You will be able to make your mistakes right, and this will lead to the overall improvement of the project. When you know the weakness of your project, you can determine how to improve it and make it better. This is going to make your project management skills strong. You can work on your weaknesses to make them strengths, and within no time, you will become one of the best project managers.

4. Make your statement credible.

You can make your statement credible by using a sensitivity analysis formula. You can apply the direct and indirect methods for sensitivity analysis according to the variable and what you want to find. You will be able to support your decision by giving proper proof for your statement. This will provide credibility for your statement and will lessen the chances of making mistakes.

5. Accurate

Sensitivity analysis is very accurate, and you will get proper results. There is a window for mistakes somehow, but if you take your variables vigilantly, you can get accurate results. This will help you to get a conclusion for making a decision. You can make proper and authentic predictions for the project as well. Thus, it will help reduce major errors in the calculation that will help you get improved results every time.

6. Simple to understand

Sensitivity analysis is very simple to understand as it is an easy method. You just have to apply a formula, and it will provide you with results. It will not even take a lot of time, and you can easily make an analysis based on the sensitivity of project elements.

Conclusion

Sensitivity analysis is a mathematical tool that is very accurate for project management. It can provide you with many benefits. Some of them are discussed in detail. You will also get a clear concept of sensitivity analysis by going through the text mentioned above. Sensitivity analysis is a proper tool for project management. Make sure that you develop a complete understanding of the sensitivity analysis so your business can benefit form it and allow you to generate a profitable income.