ACW2851 Accounting Information Systems and Financial Modelling

Lecture 4

Exploring Data Variations

Adapted from:
Beaman, Ratnutinga, Krueger, & Mudalige (2006) Financial Modelling (4th ed.)
Important

International student attendance

Learning Objectives and link
to other topics
 Learning Objectives
• Understand the difference between deterministic data
and probabilistic data, and be able to describe
alternative ways in which probabilistic data can be
incorporated in spreadsheet-based financial models.
 Exploring Data Variations
To commence our exploration of data
variations we will look at the modelling
techniques known as:
1) Scenario (what-if) analysis
a) using a data section
b) using Excel’s Data Table facility
2) Goal seek analysis
3) Sensitivity analysis
4) Probabilistic modelling
 1a) Scenario (What-if) Analysis

• Use this technique to simulate what might happen if

one or more input variables were changed

• Typically, we start with a base model (a realistic

estimate of what might happen) and then change
input variables to investigate various scenarios,
searching for a near-optimal or “satisficing”
solution
• Problem very manual and tedious process
 1b) Data (What-if) Tables
• These provide a useful way of “speeding-up” (or
automating) repeated “what-ifs”
• Can be used to calculate one or more formulas
many times, each time substituting different input
value/s in the formula/s. A table of results is
produced, one result for each set of input value/s.
• 1-variable Data Table – 1 set of input data;
multiple formulas,
• 2-variable Data Table – 2 sets of input data; 1
formula
 1b) 1-variable Data Table
• Displays the result of changing a single variable
on one or more formulas (ie. output results)
• Use the Data, What-if Analysis, Data Table
command in Excel 2007
• Question: What would be the impact on Gross
Revenue for Years 1 – 6 and the Total Gross
Revenue for the six years if Food & Drink
COGS%, vary from 20% to 50% by 2.5%
increments? Use Arthur case
Activity 7
 Solutions to Activity 7
Step 1: Set up table as in next slide.
Remember to leave an extra row (col) for
the output
Step 2: Link the table to the output. At C24,
type =C20. Then copy to I24
Step 3: Highlight from B24 to I37
Step 4: Row input cell:
Col input cell: E4
 1b) 2-variable Data Table
• Displays the result of changing a two
variables on one formula (ie. output result)
• Question: What would be the impact of Total
Gross Revenue for the six years
– if Food & Drink COGS%, varies from 25% to 40%
by 2.5% increments AND Newspapers &
Magazine COGS%, varies from 50% to 80% by
5% increments.
Activity 8
 Solutions to Activity 8
Step 1: Set up table as in next slide. Do
NOT leave any extra row (col) !
Step 2: Link the table to the output. At B23,
type =I20.
Step 3: Highlight from B23 to I29
Step 4: Row input cell: E5
Col input cell: E4
 2) What is Goal Seek?
• Also known as “backward iteration”
• Involves instructing a model to work backwards
from a desired quantified outcome (goal), to
determine the specific value that would be
needed in one (or more) input variables in order
to achieve that goal.
• Use the Data, What-if Analysis, Goal Seek
 2) How does Goal Seek process
work?
Goal seeking process involves the model
performing iterative re-calculations, each time
– substituting a value for the nominated input variable
– recalculating all dependent formulas
– checking if the output matches the goal
and repeating this ”loop” process until the goal
is achieved (or a user pre-defined iteration or
time limit is exceeded).
 2) Performing a Goal Seek
• Question: Perform a Goal Seek on your
Loan2851 model to determine how much you
could borrow (at the current annual interest rate
of 10%, 2 periods per annum, and a 5 year term)
if you can afford to repay $15,000 per period –
see activity 9
• Think about other applications where you could
use goal seeking
– Arthur – data to achieve a particular profitability level
Activity 9

• Set cell:

• To value:

• By changing cell:
Solutions to Activity 9
Output (Must be formula
only – in logic/report
section)
Input (Must be Value
only – in data section)
 3) Sensitivity Analysis
• Allows the user to identify the “key” (or
critical) input variables in a model (i.e. those
that have the greatest effect on the output)
• How?
– assess the impact on the output results of
changes made to only one input variable,
(i.e. whilst holding all other variables constant)
– a small input data change may have a large output
effect; i.e. results are highly sensitive to that input
variable
 3) Sensitivity Analysis can identify:
• Impact of changes in decision variables
• Key variables in a decision & their margin of
error or variation allowable
• Effect of uncertainty in estimating external or
uncontrollable variables
• Effect of different interactions among variables
• Robustness of decisions under changing
conditions
3) How To Perform Sensitivity Analysis
• Using excel
• Build a “sensitivity table” using formulas and graph it as
a line graph (creates a spider diagram)
• Use Excel’s Data Table facility (eg DT2 – ensure values in
first row and column increase at same rate of growth)
 3) Spider Diagram
Shows degree of sensitivity of the output variable to
each input variable using the slope of lines on the
graph (steepest slope = highest sensitivity).
Sensitivity of Net Income to Key Variables
(Using 1989 as the Base Year)
150,000

100,000
Net Income (000's)

50,000
Sales

0 COGS
70% 80% 90% 100% 110% 120% 130% Sell & Admin
-50,000

-100,000

-150,000
3) How To Perform Sensitivity Analysis
• Using external program
• Use a specialist financial modelling package such as
Insight or Optimist
Ranks and tabulates all input variables in order of sensitivity
• Use a spreadsheet “add-in” tool such as TopRank to rank
variables and produce a “Tornado”
 3) Tornado Diagram
• Uses bars or blocks to indicate the level of sensitivity of
output to each input variable (largest bars more sensitive)
• Decreasing sensitivity give diagram the shape of a
tornado
 4) Probabilistic Modelling
Up to now, we have been dealing with
deterministic data in our models
Deterministic data only has a single value entered
into the model for the input variable when we “run”
the model. This single value may be changed
before we re-run the model (i.e. to perform what-if
analysis), but we assume it is known with certainty
at that instant point in time when we run the model.
Question
How to incorporate risk and uncertainty into our
models?
 4) Probabilistic Models
• Probabilistic models incorporate:
– Risk analysis is any method, qualitative or quantitative,
for assessing the impacts of risk (uncertainty) on decision
situations. Risk analysis incorporated in the logic
(formulas) of the model or in the processing of that model
(probabilistic simulation)
– probabilistic input data. This requires the user to
specify a probability distribution for each of these
uncertain input variables. Eg normal distribution. A
probability distribution shows the range of values that the
input data could be, plus for each of these values, their
associated probabilities of occurrence.
Homework

• Pls try excel tutorial before class

• Pls read the optimisation question and
try to do it before next week’s class –
otherwise it will be confusing