Monte Carlo Simulation Formula in Excel

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MONTE CARLO SIMULATION FORMULA IN

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October 26, 2014 / Excel Tips & Tricks / By Rick Grantham / 10 COMMENTS
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What is Monte Carlo Simulation?

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Monte Carlo Simulation is a process of using probability curves to determine the likelihood of an

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outcome. You may scratch Send me
head the
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and say…Download
“Hey Rick, a distribution curve has an array
values. So how exactly do I determine the likelihood of an outcome?” And better yet, how do I d
that in Microsoft Excel without any special add-ins
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Thought you would never ask.
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This is done by running the simulation thousands of times and analyzing the distribution of the
output. This is particularly important when you are analyzing the output of several distribution
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curves that feed into one another.
Example:
» # of Units Sold may have a distribution curve

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» multiplied
FREE by Market price, which may have another distribution curve
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» minus variable wages

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» etc., etc.
Once all these distributions are intermingled, the output can be quite complex. Running thousan
of iterations (or simulations) of these curve may give you some insights. This is particularly usef
in analyzing potential risk to a decision.
Describe
Name
Monte Carlo
When describing
Email Monte Carlo Simulation, I often refer to the 1980’s movie War Games, where a
young Mathew Broderick (before Ferris Bueller) is a hacker that uses his dial up modem to hack
the Pentagon computers and start World War 3. Kind of. He then had the Pentagon computers
YES,
many simulations of the Send
games meToe
Tic Tac thetoFREE
teach Download
the computer that no one will will a nuclear
– and save the world in the process.
Thanks Ferris. You’re a hero.

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Here’s a glimpse of the movie to show you big time Monte Carlo in action. I am assuming that y
will overlook the politics, theShare
awkward man hugging
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Wargames Ending
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THEbyMONTE
Szilvia Juhasz CARLO SIMULATION FORMUL
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Distribution Curves
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There are various distribution curves you can use to set up your Monte Carlo simulation. And th
curves may be interchanged based on the variable. Microsoft doesn’t have a formula called “Do
Monte Carlo Simulation” in the menu bar
Uniform Distribution
In a uniform distribution, there is equal likelihood anywhere between the minimum and a
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maximum. A uniform distribution looks like a rectangle.
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Normal (Gaussian) Distribution
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This is also your standard bell shaped curve. This Monte Carlo Simulation Formula is characteriz
by being evenly distributed on each side (median and mean is the same – and no skewness). Th
tails of the curve go on to infinity. So this may not be the ideal curve for house prices, where a fe
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top end houses increase the average (mean) well above the median, or in instances where there
hard minimum or maximum. An example of this may be the minimum wage in your locale. Pleas
note that the name of the function varies depending on your version.
Lognormal Distribution
A distribution where the logarithm is normally distributed with the mean and standard deviation
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So the setup is similar to the normal distribution, but please note that the mean and standard_
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variables are meant to represent the logarithm.

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Poisson Distribution
This is likely the most underutilized distribution. By default, many people use a normal distribut
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curve when Poisson is a better fit for their models. Poisson is best described when there is a lar
distribution near the very beginning that quickly dissipates to a long tail on one side. An exampl
YES,where
this would be a call center, Sendnome callsthe
are FREE Download
answered before second ZERO. Followed by the
majority of calls answered in the first 2 intervals (say 30 and 60 seconds) with a quick drop off in
volume and a long tail, with very few calls answered in 20 minutes (allegedly).
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The purpose here is not to show you every distribution possible in Excel, as that is outside the
scope of this article. Rather to ensure that you know that there are many options available for y
Monte Carlo Simulation. Do not fall into the trap of assuming that a normal distribution curve is
right fit for all your data modeling. To find more curves, to go the Statistical Functions within yo
Excel workbook and investigate. If you have questions, pose them in the comments section belo
Building The Model

For this set up we will assume a normal distribution and 1,000 iterations.
Input Variables
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The
FREE setup assumes a normal distribution. A normal distribution requires three
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variables; probability, mean and standard deviation. We will tackle the mean and
standard"Laminate
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in our firstQuick
step. Guides
I assume
fora the
finance forecasting
Excel problem that consists of
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Revenue, Variable and Fixed Expenses. Where Revenue minus Variable Expenses minus Fixed
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Expenses equals Profit. The Fixed expenses are sunk cost in plant and equipment, so no
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distributioncurve & Timesavers
is assumed. for the
Distribution Powerare
curves User
assumed for Revenue and Variable Expen
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First Simulation
The example below indicates the settings for Revenue. The formula can be copy and
pasted to cell D6 for variable expenses. For Revenue and expenses we you the funct
NORM.INV() where the parameters are:
x
x
» Probability = the function RAND() to elicit a random number based on the other criteria withi
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» Mean = The mean used in the Step 1. For Revenue it is C3.
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» Standard Deviation = The Standard Deviation used in Step 1. For Revenue it is C4
Since RAND() is used as the probability, a random probability is generated at refresh. We will us
this to our advantage in the next step.
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FREE1,000
DownloadSimulations
There are several ways to do 1,000 or more variations. The simplest option is to tak
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the formula fromQuick Guides
step #2 for the
and make Excel Power
it absolute. ThenUser.
copy and paste 1,000 times.
Includes:
That’s simple, but not very fancy. And if Ferris Bueller can save the world by showing a new Tic
Toe game to a computer, then we can spice up this analysis as well. Let’s venture into the world
tables.
» First we want to create an outline for a table. We do this by listing the numbers 1 to 1,000 in
rows. In the example image below, the number list starts in B12.
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» in the next column, in cell C12, we will reference the first iteration.
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» Next highlight the area where we want to house the 1,000 iterations
» Select Data > Data Tables

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» For Column input cell: Select a blank cell. In the download file, cell D11 is selected
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» Select OK
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» Once OK is selected from the previous step, a table is inserted that autopopulates the 1,000
simulations
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Summary Statistics
Once theReference
Quick simulations are for
Guide run,Lookups
it is timeand
to gather summary
Conditional statistics. This can be do
Calculations
a number of ways. In this example I used the COUNTIF() function to determine the
percentage of simulations that are unprofitable, and the likelihood of a profit greater than $1
Million. As expected, the likelihood of greater than $1M hovers around 50%. This is because we
used normalNamedistribution curves that are evenly distributed around the mean, which was $1M. T
likelihood of losing money is 4.8%. This was gathered by using the COUNTIF() function to count t
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simulations that were less than zero, and dividing by the 1,000 total iterations.
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by Szilvia Juhasz
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Monte Carlo Simulation Formula
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 Quick Reference Guide for

Download Lookups
The Monteand Conditional
Carlo Calculations
Simulation FIle
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What?
In the video above, Oz asks about the various uses for Monte Carlo Simulation. What have you
used it for? Are there any specific examples that you can share with the group? If so, leave a no
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