In this article we will talk about:
- The result of an economic feasibility study
- How to do scenario analysis
- Scenario Analysis Report
- The right tool to do scenario analysis
I do not think I need even speak of the importance that an economic feasibility study has for a business that is starting, but if you are in doubt, it is precisely this tool that will tell you if it is worth going ahead, reformulating or giving up your idea.
Usually (and in our economic feasibility study sheet), this tool understands 3 most important variables that you need to design:
- Fixed Costs:
- Revenue (and direct costs):
If you did a good job at home, you know the market that you intend to enter, studied and was able to realistically forecast these variables, you will have a view of the main viability indicators (NPV, TIR and Payback) of your business:
See what looks like a good deal, with payback in just over a year, quite positive NPV and relatively low investment. Along with this, in our economic feasibility study sheet, you can see even a general projection of consolidated revenue, cost and profit data per year:
Now a question that not everyone does and that is essential: will you believe 100% of your money and effort in this projection?
You see, I do not want to be pessimistic or say that the result of the spreadsheet is not credible, but we live in a world where everything changes very quickly and, speaking of a projection of the future, anything can happen.
What if something different than what you planned to happen? If instead of selling 10 products per day, can you just sell 5? What if the government simply did not keep the rates you were using in projection for that year? Anyway, a lot can change and this can positively or negatively impact your economic feasibility study.
So it's always good and I recommend that in addition to the initial feasibility study, you work with analysis of different scenarios.
Scenario analysis can be used in a number of different situations, but when we apply the economic feasibility study, we are talking about creating scenarios that were not predicted at an early stage. As we know, there will always be the possibility of better or worse things happen, so we have two basic classifications of scenarios:
- Optimistic Scenario
In this case, the economic feasibility study sheet allows you to make positive changes to the three key EVE variables (revenues, costs, and investments). This type of scenario analysis is particularly good when you are interested in showing your study to potential investors or potential investors because it will really take your indicators to another level:
In the exemplified case, we increased the revenues by 20%, reduced 5% costs and 10% investments. This will generate new return indicators for the optimistic scenario analysis of the economic viability study:
See that from 17 months of payback we spent only 10 months and that of about half a million NPV, we passed to a little over a million. Just be careful not to be overjoyed with these numbers, because as we have already said, they are a projection and may not materialize.
- Pessimistic scenario
Now is the time to make changes that negatively impact your revenues and / or increase your projected costs and investments. I think this is one of the best parts of a scenario analysis because when you think of a rather adverse (but still real) scenario, you can compare the cost that scenario can have and analyze whether it is worth getting into it or not .
In the example above I decrease revenues in the pessimistic scenario in 20% and increased costs in 15% and 10% investments. These changes in our original numbers generate these business viability indicators.
Note that although the NPV and IRR are positive (which would be good indicators), the payback is above the 36 months limit of our analysis, which is a demonstration that it can take a long time to recover the money invested. It was just doing this kind of scenario analysis that a LUZ customer has not lost all of their savings on a bad investment.
Finally, if you already have this data, it is only necessary to consolidate all the scenarios in one place to be able to have a good view of the whole.
It is precisely at this moment that the economic feasibility study sheet. With them, it is extremely easy to do a visual analysis and have a sort of consolidated report of the scenarios for each of the analyzed years.
Below is a graph showing the profit or loss accumulated for the 3 years in each scenario (pessimistic in red, realistic projected in gray and optimistic in green):
It is quite easy to understand that the break-even point is reached from the first year to the realistic and optimistic scenarios, but it only occurs in the third year for the pessimistic scenario. It is also easy to understand that if you accumulate a loss of more than R $ 140.000 in the pessimistic scenario, you need to have this capital reserve so you do not get into debt or go bankrupt.
Basically these are 3 faces of the same situation that may occur in the future. It goes without saying that there is no right or wrong decision, everything will depend on how much risk you are willing to take and how much you will devote.
The most important point to understand from any feasibility study is that it is no use having the best tool if you do not make realistic and really ground-based projections, after all, Excel accepts whatever value you add on it.
That being said, all the examples (and images) I've gone through throughout this article were made using our economic feasibility study sheet, which can help you a lot if you do your homework, study your market, and make correct projections .