Using Sensitivity Analysis to Optimize Profits

Sensitivity analysis helps managers understand how changes in costs or sales affect profits.

Consider UrbFit Corporation, a fitness equipment maker with one million two hundred thousand dollars in fixed costs and a sixty percent contribution margin ratio.

The company plans to hire a marketing manager and is considering either a fixed annual salary or a commission-based compensation plan.

If the manager is paid a fixed annual salary of one hundred twenty thousand dollars, fixed costs rise to one million three hundred twenty thousand dollars. Dividing the fixed costs by the sixty percent contribution margin ratio gives a break-even point of two million two hundred thousand dollars in sales.

If the manager is paid a ten percent commission on sales, variable costs increase, and the contribution margin falls to fifty percent. The break-even point increases to two million four hundred thousand dollars in sales.

Comparing the two scenarios shows that the fixed salary keeps costs steady across all sales levels, while commission costs rise as sales grow.

Sensitivity analysis helps managers at UrbFit Corporation study these trade-offs and choose the approach that best improves profit performance.