I am preparing a financial forecast for the business plan. Talked to someone and he said I should do a sensitivity test for the forecast. Essentially, I was told to do a highwater mark and a lowwater mark for the forecast. Truth will lie somewhere in between. I googled the words "Sensitivity Test", "Financial Forecast" but did not get anything meaningful in the working mechanism in formulating these high watermark and low watermark. Anyone with some info on this willing to share their thoughts? Are the words "Sensitivity Test" the right terminology?
I think you got it right.
All you have to do is change the amounts of revenue that you expect to receive during any given period. For the lowwater mark, use a conservative, low forecast. Let's say 5 million. And for the highwater mark, use high numbers. Maybe 10 million in revenues. Also, bear in mind, that high revenues usually require high expenses (higher cost of goods sold, higher marketing expenses,... and so on). You can't simply increase revenues without increasing expenses or viceversa.
I would also add a third and more realistic scenario of expected revenues based on the industry.
I'm not a financial analyst myself but I discussed this with one.
Financial analysts usually build a model of revenues and profits as a function of various inputs (e.g. number of customers, financing costs, inflation). The revenue depends on a number of inputs, and the sensitivity analysis attempts to figure out which inputs cause the most change in revenue - in other words, which variables it's most sensitive to.
It's useful to do it because it may allow you to get a bit of insight into the risks in your forecast.
When you have the model explicitly defined, it also makes it easier to find the high and low watermarks for your forecast.