CHAPTER 6

SPREADSHEET MODELS
Introduction 2

 Spreadsheet models are mathematical and logic-based models

 Referred to as what-if models
 Provide easy-to-use, sophisticated mathematical and logical functions
 Allow for easy instantaneous recalculation for a change in model inputs
 Are less expensive
 Often come preloaded on computers
 Are fairly easy to use
 The most used business analytics tool
Building Good Spreadsheet
Models
INFLUENCE DIAGRAMS
BUILDING A MATHEMATICAL MODEL
SPREADSHEET DESIGN AND IMPLEMENTING THE MODEL IN A SPREADSHEET
 Building Good Spreadsheet Models 4

 Total cost of manufacturing a product is the sum of two costs:

 Fixed cost: Portion of the total cost that does not depend on the production
quantity and remains the same no matter how much is produced
 Variable cost: Portion of the total cost that is dependent on and varies with the
production quantity
 Make-versus-buy decision: comparing the costs of manufacturing
in-house to the costs of outsourcing production to another firm
 Building Good Spreadsheet 5
Models
• Example:
• Nowlin Plastics produces a line of cell phone covers.
Nowlin’s best-selling cover is its Viper model, a slim but
very durable black and gray plastic cover. The annual fixed
cost for the Viper cover is $234,000.
• This fixed cost includes management time, advertising, and
other costs that are incurred regardless of the number of
units eventually produced.
• In addition, the total variable cost, including labor and
material costs, is $2 for each unit produced.
Building Good Spreadsheet 6
Models
Influence Diagrams
 An influence diagram is a visual representation that shows
which entities influence others in a model
 Parts of the model are represented by circular or oval
symbols called nodes, and arrows connecting the nodes
show influence
Figure 6.1: An Influence Diagram 7
for Nowlin’s Manufacturing Cost
Figure 6.2: An Influence Diagram for
8
Comparing Manufacturing Versus
Outsourcing Cost for Nowlin Plastics
Building Good Spreadsheet 9

Models
Building a Mathematical Model
 Consider the cost of manufacturing the required units of the Viper
 As the influence diagram shows, this cost is a function of the fixed
cost, the variable cost per unit, and the quantity required
 Define notation for every node in the influence diagram:
 q = quantity (number of units) required
 FC = the fixed cost of manufacturing
 VC = the per-unit variable cost of manufacturing
 TMC(q) = total cost to manufacture q units
Building Good Spreadsheet 10
Models
 The cost-volume model for producing q units is
TMC(q) = FC + (VC × q)
 For the Viper, FC = $234,000 and VC = $2, so
TMC(q) = $234,000 + $2q
 Mathematical model for purchasing q units is
TPC(q) = Pq
P = the per unit purchase cost
TPC(q) = the total cost to outsource or purchase q units
 For the Viper, since P = $3.50, TPC(q) = 3.5q
Building Good Spreadsheet 11
Models
 Mathematical model for the savings associated with
outsourcing
S(q) = TMC(q) – TPC(q)
S(q) = the savings due to outsourcing

 Nowlin has to decide, “For what quantities is it more cost-

effective to outsource rather than produce the Viper?”

 Mathematically, this question is, “For what values of q is

S(q) > 0?”
Building Good Spreadsheet 12
Models
Spreadsheet Design and Implementing the Model in a Spreadsheet

 For the Nowlin Plastics problem, we have defined the following

components:
q, FC, VC, TMC(q), P, TPC(q), S(q)
 TMC, TPC, and S are the functions of other components, whereas
q, FC, VC, and P are not
 TMC, TPC, and S will be formulas involving other cells in the
spreadsheet model, whereas q, FC, VC, and P will just be entries
in the spreadsheet
Building Good Spreadsheet 13
Models

 The number of Vipers to make or buy for next year is really a

decision Nowlin gets to make, hence we refer to quantity q as a
decision variable

 FC, VC, and P are measurable factors that define characteristics of

the process we are modelling, hence we refer to FC, VC, and P as
parameters
Figure 6.3: Nowlin Plastics Make-Versus-
14
Buy Spreadsheet Model
Building Good Spreadsheet 15
Models
 The general principles of spreadsheet model design and
construction are:
 Separate the parameters from the model: This enables the user to
update the model parameters without the risk of mistakenly
creating an error in a formula
 Document the model and use proper formatting and color as
needed: A good spreadsheet model is well documented. Clear
labels and proper formatting and alignment facilitate navigation
and understanding
 Use simple formulas: Clear, simple formulas can reduce errors
and make maintaining the spreadsheet easier. Long and complex
calculations should be divided into several cells
What-If Analysis
DATA TABLES
GOAL SEEK
What-If Analysis 17

Data Tables
 Data Table: Excel tool which quantifies the impact of
changing the value of a specific input on an output of
interest
 One-way data table: summarizes a single input’s
impact on the output
 Two-way data table: summarizes two inputs’ impact
on the output
Figure 6.4: The Input for Constructing a 18
One-
Way Data Table for Nowlin Plastics
Figure 6.5 Results of One-Way Data
19
Table for Nowlin Plastics
 20
Figure 6.6: The Input for Constructing a
Two-Way Data Table for Nowlin Plastics
Figure 6.7: Results of Two-Way Data Table
21
for Nowlin Plastics
What-If Analysis 22

Goal Seek
 Goal Seek: Excel tool that allows the user to
determine the value of an input cell that will cause the
value of a related output cell to equal some specified
value (the goal)
 In the case of Nowlin Plastics, suppose we want to
know the value of the quantity of Vipers where it
becomes more cost effective to manufacture rather
than outsource
Figure 6.8: Goal Seek Dialog Box
23
for Nowlin Plastics
 24
Figure 6.9: Results from Goal Seek for
Nowlin Plastics
Some Useful Excel Functions
for Modeling
SUM AND SUMPRODUCT
IF AND COUNTIF
VLOOKUP
Some Useful Excel Functions for Modeling 26

SUM and SUMPRODUCT

 SUM: Function that adds up all of the numbers in a range of cells
 SUMPRODUCT: Function that returns the sum of the products of elements in
a set of arrays
Figure 6.10: What-If Model for 27
Foster Generators
 Some Useful Excel Functions for Modeling 28
IF and COUNTIF
 =IF(condition, result if condition is true, result if condition is false)
 =COUNTIF(range, condition)
 Counts the number of components having a positive order quantity
Illustration:
 Gambrell Manufacturing produces car stereos
 Gambrell likes to keep its components inventory to a minimum
 Hence, it uses an inventory policy known as an order-up-to policy
 Order-up-to policy: Whenever the inventory on hand drops below a certain
level, enough units are ordered to return the inventory to that predetermined
level
Figure 6.11: Gambrell Manufacturing Component Ordering
29
Model
 30
Some Useful Excel Functions for Modeling

VLOOKUP
 This function allows the user to pull a subset of data from a
larger table of data based on some criterion
 General form =VLOOKUP(value, table, index, range)
where,
value = the value to search for in the first column of the
table
table = the cell range containing the table
index = the column in the table containing the value to be
returned
range = TRUE if looking for the first approximate match of
value and FALSE if looking for an exact match of
value
Figure 6.12: Granite Insurance Bonus Model 31
Auditing Spreadsheet Models
TRACE PRECEDENTS AND DEPENDENTS
SHOW FORMULAS
EVALUATE FORMULAS
ERROR CHECKING
WATCH WINDOW
 Auditing Spreadsheet Models 33

 Excel contains a variety of tools to assist you in the development and

debugging of spreadsheet models
 These tools are found in the Formula Auditing group of the Formulas
tab
 Auditing Spreadsheet Models 34

Trace Precedents and Dependents

 Trace Precedents button: After selecting cells, this button creates
arrows pointing to the selected cell from cells that are part of the
formula in that cell
 Trace Dependents button: Shows arrows pointing from the selected
cell to cells that depend on the selected cell
 Both of the tools are excellent for quickly ascertaining how parts of a
model are linked
Figure 6.13: The Formula Auditing Group
 36
Figure 6.14: Trace Precedents for Foster Generator
Figure 6.15: Trace Dependents for37
the Foster Generators Model
 Auditing Spreadsheet Models 38

Show Formulas
 To see the formulas in a worksheet, simply click on any cell in the
worksheet and then click on Show Formulas—you will see the
formulas residing in that worksheet
 To revert to hiding the formulas, click again on the Show Formulas
button
 Auditing Spreadsheet Models 39

Evaluate Formulas
 The Evaluate Formulas button allows you to investigate the
calculations of a cell in great detail
 Provides an excellent means of identifying the exact
location of an error in a formula
Figure 6.16: The Evaluate Formula Dialog Box
for Gambrell Manufacturing
Figure 6.17: The Evaluate Formula Dialog Box
41
for Gambrell Manufacturing Cell B17 after
Four Clicks of the Evaluate Button
 Auditing Spreadsheet Models 42

Error Checking
 The Error Checking button provides an automatic means of
checking for mathematical errors within formulas of a
worksheet
 Clicking on the Error Checking button causes Excel to
check every formula in the sheet for calculation errors
 If an error is found, the Error Checking dialog box appears
Figure 6.18: The Error Checking Dialog Box43
for a Division by Zero Error
 Auditing Spreadsheet Models 44

Watch Window
 The Watch Window, located in the Formula Auditing group,
allows the user to observe the values of cells included in the
Watch Window box list
 Useful for large models when not all of the model is
observable on the screen or when multiple worksheets are
used
Figure 6.19: The Watch Window for Cell B17
45
of the Gambrell Manufacturing Model