LECTURE 5

Regression analysis in Excel - The basics

In statistical modeling, regression analysis is used to estimate the relationships between two or
more variables:

Dependent variable (aka criterion variable) is the main factor you are trying to understand and
predict.

Independent variables (aka explanatory variables, or predictors) are the factors that might
influence the dependent variable.

Regression analysis helps you understand how the dependent variable changes when one of the
independent variables varies and allows to mathematically determine which of those variables
really has an impact.

Technically, a regression analysis model is based on the sum of squares, which is a

mathematical way to find the dispersion of data points. The goal of a model is to get the smallest
possible sum of squares and draw a line that comes closest to the data.

In statistics, they differentiate between a simple and multiple linear regression. Simple linear
regression models the relationship between a dependent variable and one independent variables
using a linear function. If you use two or more explanatory variables to predict the dependent
variable, you deal with multiple linear regression. If the dependent variable is modeled as a
non-linear function because the data relationships do not follow a straight line, use nonlinear
regression instead. The focus of this tutorial will be on a simple linear regression.

As an example, let's take sales numbers for umbrellas for the last 24 months and find out the
average monthly rainfall for the same period. Plot this information on a chart, and the regression
line will demonstrate the relationship between the independent variable (rainfall) and dependent
variable (umbrella sales):

Linear regression equation

Mathematically, a linear regression is defined by this equation:

y = bx + a + ε

Where:

 x is an independent variable.
 y is a dependent variable.
 a is the Y-intercept, which is the expected mean value of y when all x variables are equal
to 0. On a regression graph, it's the point where the line crosses the Y axis.
 b is the slope of a regression line, which is the rate of change for y as x changes.
 ε is the random error term, which is the difference between the actual value of a
dependent variable and its predicted value.

The linear regression equation always has an error term because, in real life, predictors are never
perfectly precise. However, some programs, including Excel, do the error term calculation
behind the scenes. So, in Excel, you do linear regression using the least squares method and
seek coefficients a and b such that:

y = bx + a

For our example, the linear regression equation takes the following shape:

Umbrellas sold = b * rainfall + a

There exist a handful of different ways to find a and b. The three main methods to perform linear
regression analysis in Excel are:

 Regression tool included with Analysis ToolPak

 Scatter chart with a trendline
 Linear regression formula

Below you will find the detailed instructions on using each method.

How to do linear regression in Excel with Analysis ToolPak

This example shows how to run regression in Excel by using a special tool included with the
Analysis ToolPak add-in.

Enable the Analysis ToolPak add-in

Analysis ToolPak is available in all versions of Excel 2019 to 2003 but is not enabled by default.
So, you need to turn it on manually. Here's how:

1. In your Excel, click File > Options.

2. In the Excel Options dialog box, select Add-ins on the left sidebar, make sure Excel
Add-ins is selected in the Manage box, and click Go.
 3. In the Add-ins dialog box, tick off Analysis Toolpak, and click OK:

This will add the Data Analysis tools to the Data tab of your Excel ribbon.

Run regression analysis

In this example, we are going to do a simple linear regression in Excel. What we have is a list of
average monthly rainfall for the last 24 months in column B, which is our independent variable
(predictor), and the number of umbrellas sold in column C, which is the dependent variable. Of
course, there are many other factors that can affect sales, but for now we focus only on these two
variables:
With Analysis Toolpak added enabled, carry out these steps to perform regression analysis in
Excel:

1. On the Data tab, in the Analysis group, click the Data Analysis button.

2. Select Regression and click OK.

3. In the Regression dialog box, configure the following settings:

o Select the Input Y Range, which is your dependent variable. In our case, it's
umbrella sales (C1:C25).
o Select the Input X Range, i.e. your independent variable. In this example, it's the
average monthly rainfall (B1:B25).

If you are building a multiple regression model, select two or more adjacent columns
with different independent variables.

o Check the Labels box if there are headers at the top of your X and Y ranges.
o Choose your preferred Output option, a new worksheet in our case.
 o Optionally, select the Residuals checkbox to get the difference between the
predicted and actual values.

4. Click OK and observe the regression analysis output created by Excel.

Interpret regression analysis output

As you have just seen, running regression in Excel is easy because all calculations are preformed
automatically. The interpretation of the results is a bit trickier because you need to know what is
behind each number. Below you will find a breakdown of 4 major parts of the regression
analysis output.

Regression analysis output: Summary Output

This part tells you how well the calculated linear regression equation fits your source data.

Here's what each piece of information means:

Multiple R. It is the Correlation Coefficient that measures the strength of a linear relationship
between two variables. The correlation coefficient can be any value between -1 and 1, and its
absolute value indicates the relationship strength. The larger the absolute value, the stronger the
relationship:

 1 means a strong positive relationship

 -1 means a strong negative relationship
 0 means no relationship at all

R Square. It is the Coefficient of Determination, which is used as an indicator of the goodness of

fit. It shows how many points fall on the regression line. The R 2 value is calculated from the total
sum of squares, more precisely, it is the sum of the squared deviations of the original data from
the mean.

In our example, R2 is 0.91 (rounded to 2 digits), which is fairy good. It means that 91% of our
values fit the regression analysis model. In other words, 91% of the dependent variables (y-
values) are explained by the independent variables (x-values). Generally, R Squared of 95% or
more is considered a good fit.

Adjusted R Square. It is the R square adjusted for the number of independent variable in the
model. You will want to use this value instead of R square for multiple regression analysis.

Standard Error. It is another goodness-of-fit measure that shows the precision of your
regression analysis - the smaller the number, the more certain you can be about your regression
equation. While R2 represents the percentage of the dependent variables variance that is
explained by the model, Standard Error is an absolute measure that shows the average distance
that the data points fall from the regression line.

Observations. It is simply the number of observations in your model.

Regression analysis output: ANOVA

The second part of the output is Analysis of Variance (ANOVA):

Basically, it splits the sum of squares into individual components that give information about the
levels of variability within your regression model:

 df is the number of the degrees of freedom associated with the sources of variance.
 SS is the sum of squares. The smaller the Residual SS compared with the Total SS, the
better your model fits the data.
 MS is the mean square.
 F is the F statistic, or F-test for the null hypothesis. It is used to test the overall
significance of the model.
 Significance F is the P-value of F.

The ANOVA part is rarely used for a simple linear regression analysis in Excel, but you should
definitely have a close look at the last component. The Significance F value gives an idea of
how reliable (statistically significant) your results are. If Significance F is less than 0.05 (5%),
your model is OK. If it is greater than 0.05, you'd probably better choose another independent
variable.

Regression analysis output: coefficients

This section provides specific information about the components of your analysis:

The most useful component in this section is Coefficients. It enables you to build a linear
regression equation in Excel:

y = bx + a

For our data set, where y is the number of umbrellas sold and x is an average monthly rainfall,
our linear regression formula goes as follows:

Y = Rainfall Coefficient * x + Intercept

Equipped with a and b values rounded to three decimal places, it turns into:

Y=0.45*x-19.074

For example, with the average monthly rainfall equal to 82 mm, the umbrella sales would be
approximately 17.8:
0.45*82-19.074=17.8

In a similar manner, you can find out how many umbrellas are going to be sold with any other
monthly rainfall (x variable) you specify.

Regression analysis output: residuals

If you compare the estimated and actual number of sold umbrellas corresponding to the monthly
rainfall of 82 mm, you will see that these numbers are slightly different:

 Estimated: 17.8 (calculated above)

 Actual: 15 (row 2 of the source data)

Why's the difference? Because independent variables are never perfect predictors of the
dependent variables. And the residuals can help you understand how far away the actual values
are from the predicted values:

For the first data point (rainfall of 82 mm), the residual is approximately -2.8. So, we add this
number to the predicted value, and get the actual value: 17.8 - 2.8 = 15.

How to make a linear regression graph in Excel

If you need to quickly visualize the relationship between the two variables, draw a linear
regression chart. That's very easy! Here's how:

1. Select the two columns with your data, including headers.

2. On the Inset tab, in the Chats group, click the Scatter chart icon, and select the Scatter
thumbnail (the first one):

This will insert a scatter plot in your worksheet, which will resemble this one:
3. Now, we need to draw the least squares regression line. To have it done, right click on
any point and choose Add Trendline… from the context menu.
4. On the right pane, select the Linear trendline shape and, optionally, check Display
Equation on Chart to get your regression formula:

As you may notice, the regression equation Excel has created for us is the same as the
linear regression formula we built based on the Coefficients output.

5. Switch to the Fill & Line tab and customize the line to your liking. For example, you can
choose a different line color and use a solid line instead of a dashed line (select Solid line
in the Dash type box):
At this point, your chart already looks like a decent regression graph:

Still, you may want to make a few more improvements:

 Drag the equation wherever you see fit.

 Add axes titles (Chart Elements button > Axis Titles).
 If your data points start in the middle of the horizontal and/or vertical axis like in this
example, you may want to get rid of the excessive white space. The following tip
explains how to do this: Scale the chart axes to reduce white space.

And this is how our improved regression graph looks like:

Important note! In the regression graph, the independent variable should always be on
the X axis and the dependent variable on the Y axis. If your graph is plotted in the reverse
order, swap the columns in your worksheet, and then draw the chart anew. If you are not
allowed to rearrange the source data, then you can switch the X and Y axes directly in a
chart.

How to do regression in Excel using formulas

Microsoft Excel has a few statistical functions that can help you to do linear regression
analysis such as LINEST, SLOPE, INTERCPET, and CORREL.

The LINEST function uses the least squares regression method to calculate a straight line
that best explains the relationship between your variables and returns an array describing
that line. You can find the detailed explanation of the function's syntax in this tutorial.
For now, let's just make a formula for our sample dataset:

=LINEST(C2:C25, B2:B25)

Because the LINEST function returns an array of values, you must enter it as an array
formula. Select two adjacent cells in the same row, E2:F2 in our case, type the formula,
and press Ctrl + Shift + Enter to complete it.

The formula returns the b coefficient (E1) and the a constant (F1) for the already familiar
linear regression equation:

y = bx + a

If you avoid using array formulas in your worksheets, you can calculate a and b
individually with regular formulas:

Get the Y-intercept (a):

=INTERCEPT(C2:C25, B2:B25)
Get the slope (b):

=SLOPE(C2:C25, B2:B25)

Additionally, you can find the correlation coefficient (Multiple R in the regression
analysis summary output) that indicates how strongly the two variables are related to
each other:

=CORREL(B2:B25,C2:C25)

The following screenshot shows all these Excel regression formulas in action:

Tip. If you'd like to get additional statistics for your regression analysis, use the LINEST
function with the stats parameter set to TRUE as shown in this example.

That's how you do linear regression in Excel. That said, please keep in mind that
Microsoft Excel is not a statistical program. If you need to perform regression analysis at
the professional level, you may want to use targeted software such as XLSTAT,
RegressIt, etc.