Define sensitivity analysis. Why do managers conduct sensitivity analysis during the budget process?

What will be an ideal response

Sensitivity analysis is a what-if technique that asks what a result will be if a predicted amount is not achieved or if an underlying assumption changes. The master budget models the company's planned activities, and managers pay special attention to ensure that the results of the budgeted income statement, the budgeted balance sheet, and the budgeted statement of cash flows support key strategies. But actual results often differ from plans, so managers need to know how budgeted income and cash flows would change if key assumptions or predicted amounts in the master budget (a static budget) turn out to be incorrect. Because a flexible budget is prepared for various levels of sales volume, it is useful for sensitivity or what-if analysis and allows managers to plan for various sales levels. If managers have a better understanding of how changes in sales and costs are likely to affect net income and cash flows, they can react quickly if key assumptions or predicted amounts (such as sales price or sales volume) underlying the master budget prove to be wrong.