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GGFOA 2018 Annual Conference

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A lot of organizations develop long-range financial projections to manage their financial resources over a projected future planning period. Financial projections are based on a number of assumptions relative to either the likely growth or decline in revenue sources, operating expenditures, the estimated cost of funding the capital improvement program, future interest rates, and other variables. The assumptions used for projecting future operating revenues and expenditures are typically based on historical averages adjusted for the current and anticipated economic environment. Capital expenditures are similarly based on historical costs for similar assets again adjusted based on the current and anticipated economic environment. However, most organizations do not engage in sensitivity analysis. Sensitivity analysis is a technique for investigating the impact of changes in key variables on the base-case (most probable outcome scenario). Typically, only adverse changes are considered in sensitivity analysis. The purpose of sensitivity analysis is fourfold:

  • To help identify the key variables which influence the projected financial performance.

  • To investigate the consequences of likely adverse changes in key variables. For example:

    • Personnel cost are projected to increase 3% annually, what if they increase at either 3.5% or 4.0%?

    • Our capital improvement program estimates the cost of our new City Hall to be $5 million what if the actual cost is $5.5 million?

    • New debt is projected at an interest rate of 3.5%, what if rates rise to 4% or 4.5%?

  • To assess how operational and financial decisions are likely to be affected by such changes; and,

  • To identify actions that could mitigate possible adverse effects on your financial performance

Sensitivity analysis provides a range of possible outcomes for your financial projections that can enable you to incorporate the impacts of future uncertainties in your planning.

This article was submitted by:
Anthony King, CIPMA

Vice President

Springsted Incorporated