Chapter 6
Profit Sensitivity Analysis
Profit sensitivity analysis (PSA)
Profit sensitivity analysis (PSA) is a management
information tool that assesses how profit reacts to
changes in various key variables that make up the
overall profit figure.
It is a valuable tool in profit planning and decisionmaking as it can show which factors have the
greatest influence on profit.
Key variables
The profit multiplier or sensitivity
rating
The process in applying PSA is to take any one variable
and assess the effect on profit of changes to that
variable. For example, should sales volume increase by
10 per cent and the resulting effect on profit is an
increase of 15 per cent, then profit is deemed to be
sensitive to changes in sales volume. This sensitivity can
be measured through the profit multiplier or sensitivity
rating which in the above case is 1.5 times (15%  10%).
The profit multiplier or sensitivity rating is calculated as
follows:
Profit multiplier / sensitivity rating
=
Effect on profit
Change in key variable
Example 6.1: Profit sensitivity
analysis
A) Competition is such that sales
volume drops by 10 per cent
B) The business is forced to cut prices
by 10 per cent to maintain sales
C) Cost of raw material increases by 10
per cent
D) Variable costs increase by 10
per cent
E) Fixed costs increase by 10 per cent
Interpreting the sensitivity ratings
Key variable
Sales volume
Sales price
Cost of sales
Other variable costs
Fixed costs
Sensitivity rating
2 times
5 times
2.5 times
0.5 times
1
More sensitive to changes in selling price than to changes in
costs and changes in sales volume.
Reductions in cost of sales have a greater effect on profit than
reductions in fixed and other variable costs.
Ultimately in maintaining satisfactory profit levels, this business
should pay particular attention to pricing levels, after which it
should focus on cost of sales / variable costs and sales
volume.
Illustration 6.1: Profit sensitivity
analysis
Illustration 6.1: Profit sensitivity
analysis
Illustration 6.1: Profit sensitivity
analysis
Key variable
Sales volume
Sales price
Cost of sales
Other variable costs
Fixed costs
Sensitivity rating
8
10
1
1
7
Fixed and variable cost structures
If break-even is not
achieved, the extent of
the loss is minute
Must achieve higher
levels of sales to
break-even
To achieve high profit
levels, high volume sales
must be generated (low
contribution/sales margin)
Once break-even point is
achieved, high levels of
profit can be achieved (high
contribution/sales margin)
Limitations of sensitivity analysis
It does not assign probabilities on the possibilities of
fluctuations in key variables.
It does not consider the effect on projected
outcomes of more than one variable at a time.