Explain the term "What-If Analysis" with an example.

What-If Analysis is a decision-making technique used to evaluate the potential outcomes of different scenarios by manipulating variables or inputs in a model. This analysis helps individuals or organizations understand the implications of changes in assumptions or conditions on their results, ultimately aiding in better decision-making and planning. ### Example: Budget Planning Let's consider a company that is planning its budget for the upcoming year. The finance team has developed a financial model to project revenues, costs, and profits based on certain assumptions. 1. **Base Case Scenario**: The team starts with a base case where they assume: - Projected sales: $1 million - Variable costs: 60% of sales - Fixed costs: $200,000 Using these figures, they calculate: - Total Variable Costs = 60% of $1 million = $600,000 - Total Costs = Variable Costs + Fixed Costs = $600,000 + $200,000 = $800,000 - Profit = Sales - Total Costs = $1 million - $800,000 = $200,000 2. **What-If Scenarios**: - **Scenario 1**: What if sales increase by 10%? The team increases projected sales to $1.1 million and recalculates profits. - **Scenario 2**: What if variable costs increase to 70% of sales? The team adjusts the variable cost percentage and analyzes the profit impact. - **Scenario 3**: What if a new fixed cost of $50,000 is added? They incorporate this new fixed cost into the model to observe changes in profit. By running these what-if scenarios, the finance team can visualize how variations in sales and cost assumptions affect profitability. This analysis enables them to prepare for possible future conditions, mitigate risks, and optimize their budget decisions based on different potential outcomes.