LECTURE 1

INTRODUCTION TO SPREADSHEET
BUSINESS MODELING

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AGENDA

 Course outline
 Mathematical models to aid decision making
 Basic spreadsheet skills

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MANAGERIAL DECISION MAKING

Analysis
Model Results

Symbolic

Interpretation
Abstraction

World
Managerial
Real Judgment
World

Management Intuition
Decisions
Situation

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A SCIENTIFIC APPROACH

Define the Problem

Identify the Alternatives

Determine the Criteria Modeling

Problem Analysis
Solving Evaluate the Alternatives

Recommend an Alternative

Implement the Decision Decision

Evaluate the Results

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EXAMPLE

 You operate a bakery and need to determine advertising expenses for November and
December.
 Previous years’ experience tells you that the monthly demand is correlated with the
monthly advertising expenditure. The effectiveness of advertising depends on the
month: Demand

 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑜𝑧𝑒𝑛 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡 ln 𝑎𝑑𝐸𝑥𝑝𝑒𝑛𝑠𝑒

 Past experience tells us that 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡 50, 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡 75
 Selling price: $96/dozen
 Cost of ingredients = $50/dozen
Expense
 Other fixed costs = $10,000 per month
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 MATHEMATICAL MODELS
 Model
 Abstraction of a real thing or process; some elements must be omitted
 Contains decision variables and represents a system in mathematical terms
 Finds values of decision variables which will improve system performance
 Used as a guide for aiding decision making
 Uses of Models
 To improve the existing decision
 To increase the understanding of a system
 To explicitly make trade-offs for a decision

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ELEMENTS OF MODELS

 Decisions: choices, possible actions, controllable variables; decision variables

 Outcomes: performance measures, criteria, eventual consequences; objective
function
 Data: information, environmental conditions, uncontrollable variables;
parameters
 Structure: relations, causes and effects, logics; equations or inequalities

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DECISIONS, OUTCOMES, DATA - EXAMPLE

 Decisions: choices, possible actions, controllable variables; decision variables

 How much should we spend on advertising in November and December?
 First attempt: $1,000 per month
 Outcomes: performance measures, criteria, eventual consequences; objective
function
 Maximize monthly income (profit) in November and December
 Data: information, environmental conditions, uncontrollable variables; parameters
 Selling price (per dozen cookies)
 Cost of ingredients (per dozen cookies)
 Advertising effectiveness factor 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡
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STRUCTURE OF MODEL - EXAMPLE

Net income

Revenue Cost

$96 Production cost +

Other fixed costs +
Selling price Production Monthly advertising
expense = Cost
(dozen) cost

Monthly Cost of Other fixed

demand chocolate (lb) costs

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Monthly
advertising
expense
 STRUCTURE OF MODEL - EXAMPLE

 Structure: relations, causes and effects, logics; equations or inequalities

 Monthly income = 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 – 𝑐𝑜𝑠𝑡𝑠
 Revenue = 𝑠𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑑𝑜𝑧𝑒𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑜𝑧𝑒𝑛)
 Cost of production = 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑑𝑜𝑧𝑒𝑛 𝑑𝑒𝑚𝑎𝑛𝑑 𝑑𝑜𝑧𝑒𝑛𝑠
 Operating costsmonth = 𝑎𝑑𝐸𝑥𝑝𝑒𝑛𝑠𝑒 𝑜𝑡ℎ𝑒𝑟 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
 Demand(dozen)month = 𝑎𝑑𝐸𝑓𝑓𝑒𝑐𝑡 ln 𝑎𝑑𝐸𝑥𝑝𝑒𝑛𝑠𝑒

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 SPREADSHEET MODEL

Decisions Can change

Outputs
Our goal

Inputs What we know

Calculation

Dont type in numbers

Refer to inputs

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SPREADSHEET MODEL

Highlight the output to increase user-friendliness.

=$C$13*C24; Use of $ in “C13” creates an “absolute

reference” that doesn’t change when we copy the formula
to the next column.

When we copy this cell to column D, we will see

“=$C$13*D24”

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 BEST PRACTICE GUIDELINES IN SPREADSHEET
DESIGN

 Sketch the spreadsheet

 Organize the spreadsheet into modules
 Isolate input parameters
 Keep it simple
 Avoid long formulas
 Formulas only contain cell references (i.e. not numbers); this simplifies
spreadsheet auditing
 Design for communication
 Use Excel formatting options (outlines, colours, bold font, etc) to highlight
certain cells for quick visual recognition
 Document important data and formulas 13
 “WHAT-IF” ANALYSIS
 Questions:
 What if we vary advertising expenses in November and December between $1,000 to
$10,000 (can be different in each month)? Modify the corresponding decision cell (C5,
D5).
 What selling price would result in a total income of $0 (break-even)? Try different
values for the parameter cell C13.
 Better solution: Use scenario analysis functions in Excel.
 Data Tab ⇒ Forecast ⇒ What-if Analysis
 Data table – Re-compute the output as we vary ONE or TWO parameters along a
range of values.
 Scenario manager – Re-compute the output for different scenarios where we may vary
any number of parameters.
 Goal Seek – Determine the parameters that would give us the desired output.
 See “ModelAnalysis.xlsx” 14
 WHY SPREADSHEET MODELING ?
 Examples of spreadsheets:
 Microsoft Excel – still the industry standard…
 Numbers
 Google Spreadsheets
 Open office spreadsheet
 Advantages:
 Ubiquity
 Availability of Add-ins
 Low cost alternative to more specialized tools (statistics, optimization)
 Disadvantages:
 Data size limitations, slow calculation speeds (large models)
 Difficult to document and organize models 15

 Often insufficient for advanced analysis