Scenario analysis.

When building a real financial model analysts need to recognize that there is inherent uncertainty in their forecasts and it's good practice to demonstrate the extent of this uncertainty by the use of scenario analysis.

These scenarios can be used to sensitize the key assumptions in a model. Typically analyst sensitize revenue growth and margin assumptions for each segment since these are the most important assumptions in a model. Also when sensitizing a model the analyst will typically assume a base case. That's the most likely outcome and then provide an upside case that uses more bullish but still reasonably likely assumptions and a downside case that uses more bearish but still reasonably likely assumptions. The scenarios are then usually numbered here the upside case in scenario 1, the base case scenario 2, and the downside case of scenario 3 and we can then use an Excel function to bring the scenario into the model based on the user selecting a scenario number. There are three potential functions that we can use for building scenarios into our model. The first is the choose function, the second is the offset function, and the third is the index function.