What is PEST Analysis?
PEST Analysis is a strategic 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 Planning, 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.
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:
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 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 Banks and other Government Agencies.
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.
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
- Career Attitudes
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&D Activity
- Technological Incentives
- The rate of change in technology
PEST Analysis in Business Valuation
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 Model – it’s important to understand how these factors will impact the company’s ability to generate cash flow.
Breaking down the external environment helps identify key elements to be incorporated into your business valuation. PEST Analysis is also useful for company screening, setting criteria that have to be fulfilled for analysis to be considered.
Learn more in CFI’s financial modeling courses.
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! Also, check out the following CFI resources: