Introduction to Spreadsheets and Models

Spreadsheet Modeling (MBA Sem I)

Credits:2

Course Content

• Spreadsheets as tool for thinking with numbers

• Spreadsheets to Models

• Statistical operations in Excel and Spreadsheets

• Linear Programming in Excel and Spreadsheets

A little history

• Use of computers to support business decisions was since the start of the computers in 1940’s.

• However, in 1970’s the advent of “personal computers” revolutionized the way business decisions are taken

Much credits goes to

Steve Jobs and Steve Wozniak

However

• Dan Bricklin and Bob Frankston were students in the late 1970s in Boston.

• Students were asked each week to review financial ledgers and then recalculate all the numbers on them based on changes requested by the professor. Now that meant some very long hours of work with a handheld calculator.

• Dan and Bob thought maybe there could be a better way. They purchased one of the new microcomputers that were available at that same time, and they wrote a program for one of them that put the financial ledgers on a computer screen. The result was the electronic spreadsheet, VisiCalc, the original killer application.

• It was the spreadsheet that drove the huge sales of Apple computers and launched the personal computer revolution.

From Ledgers to Spreadsheets

• Spreadsheets made the processes required by accountants and financial analysts more efficient.

• Spreadsheets are not just calculating machines. Here you can play with ideas, examine ideas from a qualitative perspective.

• Using Spreadsheets one can model future, play around with different decisions, different assumptions about how business scenarios might unfold, and think with numbers.

What are models?

• Mental model: A decision-making process we conduct in our heads.

• Visual model: A model in which graphics or diagrams are used to convey real objects or situations. Examples are a map or a graph.

• Physical model: A model in which physical objects are used to represent the real objects or situation, usually on a smaller scale. Examples are model cars and buildings.

• Mathematical model: A model in which quantitative relationships are used to represent a real situation or phenomenon. An example is a weather prediction model.

• Spreadsheet model: A mathematical model implemented in the form of a computer spreadsheet.

Model: A purposeful representation of the key

factors in a situation and the relationships amongthem.

Basic Mathematical model

Mathematical model: set of relationships

(Spreadsheet formulas)

Uncontrollable inputs

(parameters)

OutputsControllable

Inputs (Decision variables)

Spreadsheet modelling process

Basic steps in order to develop an effective spreadsheet model

1. Ironically, the first step is to switch-off your computer and draw a picture of to better understand the situation. Identify the uncontrollable inputs, the decision variables, and the outputs. Define the logic necessary to transform the inputs into the outputs.

2. On paper, sketch out an overall plan for the model. In general, group the inputs together. Determine where the inputs, intermediate calculations, and outputs will go. Plan to highlight the key inputs and outputs to make the model easier to use for what-if analysis. Determine the formulas relating the inputs to the intermediate calculations and outputs. This can be very simple for some models (i.e., Profit revenue expenses), or it may be quite complicated.

Steps…

3. Develop the base case spreadsheet model. Group the inputs together logically. It usually helps to use a color-coding scheme so the user can quickly determine what are the inputs and outputs of the model. Break down the intermediate calculations so that each formula is relatively simple.

4. Test the spreadsheet model using trial values. Verify the results by hand, if possible. If you have broken down the intermediate calculations into relatively simple formulas, this step is much easier.

Steps…

5. Use the model to perform the needed analysis. This may involve a relatively simple calculation, preparation of a chart, or more substantial analysis. Two common types of analysis are scenario analysis and sensitivity analysis.

6. Document the model so that others can easily understand it. Indeed, ideal spreadsheet models are almost “self-documenting” as a result of the way you organize and label them.

Evaluating Spreadsheet model

• Correct: A model is correct if it produces the numerically correct values for the outputs for the current values of the inputs.

• Flexible: A model is flexible if it produces the numerically correct values for the outputs for any legitimate values of the inputs, without making any changes to the formulas in the model.

• Document: A model is documented if someone else generally familiar with the situation can understand the model without having the model developer explain it in detail. A documented model can be put away for months at a time, and when viewed again by the modeler, is readily understandable.

Example 1: Modeling the Break-even

• Relaxo is considering whether to produce a new line of footwear. The company has considered both the processing needs for the new product and the market potential. The company also estimated that the variable cost for each product manufactured and sold is ₹550 and the fixed cost per year is ₹30,00,000. The selling price is ₹1550 per pair.

• All example files of the cases discussed in class are available at this link:

https://drive.google.com/open?id=0BwrkMoGfP6VPRkRMRUNmckxmam8