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Importance Of Risk Analysis

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• In the context of financial management, managers need to evaluate the following (aka Risk analysis), when embarking on projects: - uncertainty of forecasted future cashflow streams, variance of portfolio and stock returns, statistical analysis to determine the probability of a project's success or failure, and possible future economic states (i.e. profit or loss-making).
• Risk analysis is a technique used to identify and assess all major unknown and uncertain factors inherent in a project. It also defines preventive measures to reduce the probability of these factors from occurring and identifies reactive measures to successfully deal with these constraints, when they start to develop.
• The purpose of Risk analysis is to identify …show more content…

“Sensitivity analysis helps to prevent rash predictions about the outcome of plans by ensuring that the assumptions on which the plans are based are examined and that the effect of changes in these assumptions is gauged. This process may involve challenging the original assumptions and could result in a rethink about the project. In presenting a range of possible outcomes, Sensitivity analysis facilitates the development of alternative or contingency plans if the basic assumptions have to be changed.” (Michael, A. …show more content…

• The differences Between Sensitivity and Scenario Analysis can be summarized below: -

Basis of Comparison
Sensitivity Analysis
Scenario Analysis
Nature of Risk Predictive Not predictive (but more analytical to differing scenarios faced by firms)
Usage in Decision Making Used strategically in decision making (how much a change in the value of a variable will affect outcome) Used strategically in decision making (examines different contexts in which a project may be executed efficiently)
Context of Analysis How much a change in the value of a variable will affect outcome/ NPV Examines different context in which a project may be executed
Application of Variables/ Value Driver Each value driver is analysed independently at a given time (with no interactions between variables) All multiple value drivers are analysed simultaneously (considers interactions between all variables of the project at the same time)
Scenario No study of different scenarios of the project (all variables assumed to be in the same scenario) Evaluation and comparison between differing scenarios
Probability Analysis Does not consider probability of concurrence Attaches a probability of occurrence to each scenario

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