PEST Analysis

What is PEST Analysis?

PEST Analysis is a strategicStrategyCorporate and business strategy guides. Read all CFI articles and resources on business and corporate strategy, important concepts for financial analysts to incorporate in their financial modeling and analysis. First mover advantage, Porter's 5 Forces, SWOT, competitive advantage, bargaining power of suppliers framework used to evaluate the external environment for a business by breaking down opportunities and threats into Political, Economic, Social, and Technological factors. PEST analysis can be an effective framework to use in Corporate Strategy PlanningCorporate StrategyCorporate Strategy focuses on how to manage resources, risk and return across a firm, as opposed to looking at competitive advantages in business strategy, useful in identifying the pros and cons of a Business Strategy. Below we break down each of the 4 Factors of PEST – Political, Economic, Social, Technological.

From CFI’s Business & Corporate Strategy Course.

Political Factors

When looking at political factors, you are looking at how government policy and actions may affect the economy, as well as the specific industry the business operates in. These include the following:

• Tax PolicyAd Valorem TaxThe term “ad valorem” is Latin for “according to value,” which means that it is flexible and depends on the assessed value of an asset, product or service.
• Labor Law
• Environmental Law
• Trade Restrictions Trade BarriersTrade barriers are legal measures put into place primarily to protect a nation's home economy. They typically reduce the quantity of goods and services that can be imported. Such trade barriers take the form of tariffs or taxes and
• Tariffs

One of the reasons that elections tend to be a period of uncertainty for a country is that different political parties have diverging views on economic policy. The P in PEST analysis stands for Political!

Economic Factors

Economic Factors take into account the various aspects of the economy, and how the outlook on each area could impact your business. These economic indicators are usually measured and reported by Central BanksEuropean Central BankThe European Central Bank (ECB) is one of the seven institutions of the EU and the central bank for the entire Eurozone. It is one of the most critically important central banks in the world, supervising over 120 central and commercial banks in the member states. and other Government Agencies.

• Economic Growth rates Gross Domestic Product (GDP)Gross domestic product (GDP) is a standard measure of a country’s economic health and an indicator of its standard of living. Also, GDP can be used to compare the productivity levels between different countries.
• Interest Rates Interest RateAn interest rate refers to the amount charged by a lender to a borrower for any form of debt given, generally expressed as a percentage of the principal.
• Exchange Rates Fixed vs. Pegged Exchange RatesForeign currency exchange rates measure one currency's strength relative to another. The strength of a currency depends on a number of factors such as its inflation rate, prevailing interest rates in its home country, or the stability of the government, to name a few.
• InflationInflationInflation is an economic concept that refers to increases in the price level of goods over a set period of time. The rise in the price level signifies that the currency in a given economy loses purchasing power (i.e., less can be bought with the same amount of money).

Often these are the focus of external environment analysis. The Economic outlook is of extreme importance for a business, but the importance of the other PEST factors should not be overlooked.

Social Factors

PEST analysis also takes into consideration social factors, which are related to the cultural and demographic trends of society. Social norms and pressures are key to determining a society’s consumerist behavior. Factors to be considered include the following:

• Cultural Aspects
• Health Consciousness
• Population Growth Rates
• Age Distribution
• CareerCareersSearch CFI's career resources library. We've compiled the most important career resources for any job in corporate finance. From interview prep to resumes and job descriptions, we've got you covered to land your dream job. Explore guides, templates, and a wide range of free resources and tools Attitudes

Technological Factors

Technological Factors are linked to innovation in the industry, as well as innovation within the overall economy. Not being up to date on the latest trends of a particular industry can be extremely harmful to operations. Technological Factors include the following:

• R&DResearch and Development (R&D)Research and Development (R&D) is a process by which a company obtains new knowledge and uses it to improve existing products and introduce new ones to its operations. R&D is a systematic investigation with the objective of introducing innovations to the company’s current product offerings. Activity
• Automation
• Technological Incentives
• The rate of change in technology

PEST Analysis in Business Valuation

PEST analysis is an important aspect of a DCF Valuation ModelDCF Analysis Pros & ConsThe discounted cash flow analysis is a powerful tool in a financial analyst’s belt. However, there are many important DCF Analysis Pros & Cons for analysts, as discussed in CFI’s Business Valuation Modeling Course.

Combined, these four factors have a profound impact on the opportunities and threats for a business going forward. Before creating a business valuation model – such as a DCF ModelDCF Model TemplateThis DCF model template provides you with a foundation to build your own discounted cash flow model with different assumptions. DCF Step 1 – Build a forecast The first step in the DCF model process is to build a forecast of the three financial statements, based on assumptions about how the business will perform in the – it’s important to understand how these factors will impact the company’s ability to generate cash flowCash FlowCash Flow (CF) is the increase or decrease in the amount of money a business, institution, or individual has. In finance, the term is used to describe the amount of cash (currency) that is generated or consumed in a given time period. There are many types of CF.

Breaking down the external environment helps identify key elements to be incorporated into your business valuation. PEST Analysis is also useful for company screening and setting criteria that have to be fulfilled for analysis to be considered.

Learn more in CFI’s financial modeling courses.

Additional Resources

If you want to learn more about External Environment Analysis and how it applies to DCF Models and Valuation, take a look at the Business Valuation Model Course, part of the FMVA™ Program! FMVA® CertificationJoin 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari Also, check out the following CFI resources:

• SWOT Analysis SWOT AnalysisA SWOT analysis is used to study the internal and external environments of a company and is part of a company’s strategic planning process. In addition, a
• DCF Model DCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business. The model is simply a forecast of a company’s unlevered free cash flow
• Strategy Course 
• Economic IndicatorsEconomic IndicatorsAn economic indicator is a metric used to assess, measure, and evaluate the overall state of health of the macroeconomy. Economic indicators