Error Free? Spreadsheet Risks and Techniques

Dr Anthony Berglas, SCSQ
Peter Hoare, KPMG

Published in Australian CPA, 68 (3) , April 1998 pp 42–45


Spreadsheets have become an essential tool for performing financial modelling and analysis because they enable powerful emulation of real world business opportunities.  This enables comprehensive models to be built for financial forecasting using business drivers such as market share and production yields.  These models enable the input values to be easily varied to perform “what-if” analysis or even apply Monte Carlo simulation to gain a better understanding of the potential impact of business risks on the bottom line.

The example in exhibit 1 has been used to model the profitability of producing a product, and the Excel Solver has then been used to determine the optimum Price.  This would be difficult to do accurately using paper based calculations or calculus.  Based on this model one can confidently begin a marketing campaign advertising a price of $31.50.  One could then just as confidently sustain a significant loss because like many spreadsheet models, this one contains serious errors!

Exhibit 1

Exhibit 1

Error Studies

There is considerable evidence that a large proportion of spreadsheets that are used to make important decisions contain substantial errors.  For example,  Freeman 1996 reports that a survey found that 90% of spreadsheets with over 150 rows contained at least one significant formula mistake.  www.cba.hawaii.edu/panko/ssr provides several anecdotes of spreadsheet errors that had cost companies millions of dollars.

Errors can be hard to find, as illustrated by Galletta et al 1996 who performed an experiment in which 113 MBA students were asked to validate a single model seeded with eight errors, but on average only half the errors were identified.   Galletta also noted that subjects were more accurate when working with printed reports rather than debugging spreadsheets interactively.  Davis & Ikin 1987 audited 19 operational models and found that 4 had serious errors despite the fact that the subjects were very confident that the spreadsheets were error free.   Panko 1998,  also performed an experiment in which subjects stated they considered that there was an 18% chance that their completed spreadsheets contained errors, while in fact 86% contained errors.  Moreover, there was no correlation between each subject's level of confidence and the integrity of their completed spreadsheets.

This overconfidence is perhaps the most serious aspect of spreadsheet errors because it reduces the extent to which people validate their models before using them to make important decisions.  Mistakes that make large changes to output values are relatively easy detect.  It is the errors that lead to subtle but important changes that are most dangerous because they can be very hard to detect but still lead to seriously flawed conclusions.

Techniques for building models

A useful technique is to clearly identify cells that contain formulas as opposed to just constants.  Cells with formulas can be automatically selected in Excel by using the Edit/Go To/Special dialog or by the Tools/Audit dialog in 1-2-3 version 5.  The format of the selected cells can then be updated, perhaps by setting the background colour to blue as illustrated by exhibit 1.  This makes it easy to see that cell E7 does not have a formula, which is clearly an error.  The new version 97 of 1-2-3 has replaced the Audit dialog with a new option that enables dots to be automatically placed in cells with formulas, and the use of this option is strongly recommended.  If a spreadsheet is to be used by people other than its author, it is also good practice to protect those cells with formulas from being modified.

Another common and subtle source of error results from formulas that have not been copied consistently throughout a spreadsheet.  This can checked in Excel by using the Go To / Special dialog or the "Ctrl+\" and "Ctrl+|" keys to select cells that are inconsistent with the first column (or row) within a range of cells.   Exhibit 2 shows the result of selecting the range C5:F11 and then pressing "Ctrl+\".  This shows that cell F9 is inconsistent with cell C9.  Excel has also selected the range D11:F11 even though these cells are consistent because they are not consistent with the empty cell C11, and so this range needs to be checked separately by first selecting D11:F11 and then pressing "Ctrl+\" again.  Likewise the range G6:G10 needs to be selected before "Ctrl+|" is pressed.  Applying this option repeatedly throughout a spreadsheet and interpreting the somewhat cryptic results is tedious, but inconsistent formulas are a potentially serious source of error.

Exhibit 2

Exhibit 2

Another problem in larger spreadsheets it that it can be difficult to validate "A1" cell references.  In the example, it is difficult to understand the formula "=Price - Prod!E56" in cell F2  because "E56" does not describe the meaning of the cell being referred to.  To address this problem,  a range may be given a Name which can then be used within the formulas.  In the example, the Name "Price" has been defined to refer to the range C2, and then the Name "Price" has been used in the formula in cell F2.   The use of Names makes formulas easier to understand but can be very misleading if a Name's definition is incorrect.  In the example, cell C10 contains the formula "= C7 - PlantEquip - C9", but the Name PlantEquip actually refers to row 9 and not row 8.  For this reason Names should only be used for cells that are referenced by several different formulas, and then the definitions of these Names needs to be checked carefully. 

Excel 97 has also introduced a new "natural language" capability which enables cell labels such as "Plant & Equipment" to be entered directly into formulas.  However, this requires Excel to use heuristics to infer which cells are actually being referenced, which can occasionally produce misleading results.  We therefore recommend that if this feature is used at all that extreme care be taken.

The following guidelines should also be used when writing spreadsheets:-
An independent review of a spreadsheet is one of the most important means of obtaining some comfort as to model integrity.  A major pitfall is delegating too far this often critical role. The person assigned this job should be fully briefed on the purpose of the model, how it is structured and the key results of the model.  In our experience, the review is most effectively done on screen with input variables verified against source records, formulae logic checked and the application of the formulae to input data tested.  All this should be documented on a hard copy document.

Model Checking Tools

One solution to the problem of understanding and validating spreadsheet models is to use third party tools such as the Spreadsheet Detective (www.SpreadsheetDetective.com) which has been developed by the first author.   Exhibit 3 shows how the Detective has used blue shading and horizontal or vertical stripes to clearly indicate which cells have formulas and whether they have been copied from a cell to their left or above respectively.  Unlike Excel's Edit/Go To/Special option,  all the formulas in a spreadsheet can be properly classified at the same time.


Exhibit 3

Exhibit 4 shows annotations that describe the formulas more accurately.  The blue text in each red box contains the text of the formula in the corresponding cell, thus cell C9 contains the formula " =30%*C7".  The dots and lines show how the formula has been copied throughout the spreadsheet, so cell E9 contains " =30%*E9" but F9 contains a different formula.  The circle in E7 indicates that it does not contain a formula, while the lines with "R"s highlights the fact that the ranges being used by the Sum in cell G6 does not include C6.

A1 references have also been clarified by inserting abbreviations of labels that describe them in the annotation.  Thus the annotation in cell C9 is actually "= 30% * C7`GrossProfit".  The green annotation in B9 indicates that the Named range "PlantEquip" has been defined to be the range C9:G9, which makes it easy to see the error with this definition.

The annotated spreadsheet can be printed and soberly reviewed.  User experience with FormScheme indicates that in many instances review time can be dramatically reduced (by the order of one half to two thirds of the time) and the quality of the review enhanced.


Exhibit 4


Survey and anecdotal evidence suggests that spreadsheet errors are common.  These errors could potentially cost companies millions of dollars in new projects and other business decisions.  
An appropriate response to these risks is to:-


Panko, R. and Halverson R. 1996. Spreadsheets on Trial: A Survey of Research on Spreadsheet Risks.  Proc. Hawaii International Conference on System Sciences.
Freeman, D. 1996.  How to Make Spreadsheets Error-Proof, Journal of Accountancy, Vol 181 Nr 5 May 1996.
Davis, N. and Ikin, C.  1987.  Auditing Spreadsheets, Australian Accountant Dec 1987.
Galletta D.; Hartzel, K.; Johnson, S.; Joseph, J. and Rustagi, S. 1996.  An Experimental Study of Spreadsheet Presentation and Error Detection.  Proc. Hawaii Intl. Conf. on System Sciences.

Dr Anthony Berglas has a doctorate in computer science which investigated technology for end user computing, and can be contacted by E-Mail at ABerglas@uq.net.au. 
Peter Hoare, B Bus MBA ACA ASIA is a senior consultant with KPMG Management Consulting.