Chapter 6 (spreadsheet model) (1)

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CHAPTER 6

SPREADSHEET MODELS

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Introduction
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Spreadsheet models are mathematical and logic-based
models

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Referred to as what-if models
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Provide easy-to-use,
logical functions

sophisticated

mathematical

and

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Allow for easy instantaneous recalculation for a change in

model inputs

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Are less expensive

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Often come preloaded on computers

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Are fairly easy to use

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The most used business analytics tool

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Building Good
Spreadsheet Models
INFLUENCE DIAGRAMS
BUILDING A MATHEMATICAL MODEL
SPREADSHEET DESIGN AND IMPLEMENTING THE MODEL IN A SPREADSHEET

Building Good Spreadsheet

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

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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

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Building Good Spreadsheet

Models

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Example:

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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.

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This fixed cost includes management time, advertising,
and other costs that are incurred regardless of the
number of units eventually produced.

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In addition, the total variable cost, including labor and
material costs, is $2 for each unit produced.

Building Good Spreadsheet
Models

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Influence Diagrams
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An influence diagram is a visual representation
that shows which entities influence others in a
model

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Parts of the model are represented by circular or
oval symbols called nodes, and arrows
connecting the nodes show influence

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Figure 6.1: An Influence Diagram
for Nowlin’s Manufacturing Cost

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Figure 6.2: An Influence Diagram for
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Comparing
Manufacturing
Versus
Outsourcing Cost for Nowlin Plastics

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Building Good Spreadsheet
Models

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Building a Mathematical Model
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Consider the cost of manufacturing the required units of
the Viper

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As the influence diagram shows, this cost is a function of
the fixed cost, the variable cost per unit, and the
quantity required

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Define notation for every node in the influence diagram:
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q = quantity (number of units) required

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FC = the fixed cost of manufacturing

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VC = the per-unit variable cost of manufacturing

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TMC(q) = total cost to manufacture q units

Building Good Spreadsheet
Models
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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

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For the Viper, since P = $3.50, TPC(q) = 3.5q

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Building Good Spreadsheet
Models

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Mathematical model for the savings associated
with outsourcing
S(q) = TMC(q) – TPC(q)
S(q) = the savings due to outsourcing

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Nowlin has to decide, “For what quantities is it
more cost-effective to outsource rather than
produce the Viper?”

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Mathematically, this question is, “For what values
of q is S(q) > 0?”

Building Good Spreadsheet
Models

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Spreadsheet Design and Implementing the Model in a
Spreadsheet

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For the Nowlin Plastics problem, we have defined the
following components:
q, FC, VC, TMC(q), P, TPC(q), S(q)

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TMC, TPC, and S are the functions of other components,
whereas q, FC, VC, and P are not

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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

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Building Good Spreadsheet
Models

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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

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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 Make14
Versus-Buy Spreadsheet Model

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Building Good Spreadsheet
Models

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The general principles of spreadsheet model design and
construction are:
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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

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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

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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

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What-If Analysis

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Data Tables
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Data Table: Excel tool which quantifies the
impact of changing the value of a specific
input on an output of interest

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One-way data table: summarizes a single
input’s impact on the output

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Two-way data table: summarizes two inputs’
impact on the output

Figure 6.4: The Input for Constructing
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One-Way Data Table for Nowlin Plastics

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Figure 6.5 Results of One-Way
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Data Table for Nowlin Plastics

Figure 6.6: The Input for Constructing 20
a
Two-Way Data Table for Nowlin Plastics

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Figure 6.7: Results of Two-Way Data
Table for Nowlin Plastics

What-If Analysis

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Goal Seek
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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)

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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

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Figure 6.8: Goal Seek Dialog Box
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for Nowlin Plastics

Figure 6.9: Results from Goal Seek for 24
Nowlin Plastics

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Some Useful Excel
Functions for Modeling

SUM AND SUMPRODUCT
IF AND COUNTIF
VLOOKUP

Some Useful Excel Functions for Modeling26
SUM and SUMPRODUCT
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SUM: Function that adds up all of the numbers in a range of cells

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SUMPRODUCT: Function that returns the sum of the products of
elements in a set of arrays

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Figure 6.10: What-If Model for
Foster Generators

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Some Useful Excel Functions for Modeling
IF and COUNTIF
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=IF(condition, result if condition is true, result if condition is false)

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=COUNTIF(range, condition)
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Counts the number of components having a positive order
quantity

Illustration:
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Gambrell Manufacturing produces car stereos

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Gambrell likes to keep its components inventory to a minimum

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Hence, it uses an inventory policy known as an order-up-to
policy

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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

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Figure 6.11: Gambrell Manufacturing
Component Ordering Model

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Some Useful Excel Functions for Modeling
VLOOKUP
u This function allows the user to pull a subset of data
from a larger table of data based on some criterion
u 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

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Figure 6.12: Granite Insurance Bonus Model

Auditing Spreadsheet
Models
TRACE PRECEDENTS AND DEPENDENTS
SHOW FORMULAS
EVALUATE FORMULAS
ERROR CHECKING
WATCH WINDOW

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Auditing Spreadsheet Models

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Excel contains a variety of tools to assist you in the
development and debugging of spreadsheet models

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These tools are found in the Formula Auditing group of the
Formulas tab

Auditing Spreadsheet Models

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Trace Precedents and Dependents
u 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
u Trace Dependents button: Shows arrows pointing from the
selected cell to cells that depend on the selected cell
u Both of the tools are excellent for quickly ascertaining how
parts of a model are linked

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Figure 6.13: The Formula Auditing Group

Figure 6.14: Trace Precedents for Foster 36
Generator

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Figure 6.15: Trace Dependents for37

the Foster Generators Model

Auditing Spreadsheet Models

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Show Formulas
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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

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To revert to hiding the formulas, click again on the Show
Formulas button

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Auditing Spreadsheet Models

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Evaluate Formulas
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The Evaluate Formulas button allows you to
investigate the calculations of a cell in great
detail

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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

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Figure 6.17: The Evaluate Formula Dialog
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Box for Gambrell Manufacturing Cell B17
after Four Clicks of the Evaluate Button

Auditing Spreadsheet Models

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Error Checking
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The Error Checking button provides an automatic

means of checking for mathematical errors within
formulas of a worksheet

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Clicking on the Error Checking button causes
Excel to check every formula in the sheet for
calculation errors

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If an error is found, the Error Checking dialog box
appears

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Figure 6.18: The Error Checking Dialog 43
Box for a Division by Zero Error

Auditing Spreadsheet Models

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Watch Window
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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

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Useful for large models when not all of the model
is observable on the screen or when multiple
worksheets are used

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Figure 6.19: The Watch Window for Cell
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B17 of the Gambrell Manufacturing
Model

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