How much debt financing will the Body Shop need over this forecast period

Approved Logo 1 Sept 2013

Student Name and ID # Heba Bannoub 1320048

Tuleen Basrawi 1310186

Lara Hamza 1310043

Course Financial Policy

BNFN 4304

Section 1
Assignment # Case one
Due Date September 25th , 2018
Instructor Masood Aijazi

Question One:

Why would a company like the Body Shop want to forecast its financial statements? How did you prepare your forecast and what numbers did you get?

As mentioned in the case, in 1998, Patrick Gournay was positioned as the new CEO after Anita Roddick, the founder of the Body Shop, resigned from her position. Even though with this management change the problems continued. The Body Shop revenue increased by 13% and its pretax profit dropped by 21%. These results made the Gournay, new CEO, frustrated as he said, “This is below our expectations, and we are disappointed with the outcome.” Moreover, Gourany had a new strategy to implement that he believe it would improve the results. This strategy comprised of three main objectives, which are to enhance The Body Shop Brand through a focused product strategy and increased investment in stores, to achieve operational efficiencies in the Body Shop’s supply chain by reducing product and inventory costs, and to reinforce the firm’s stakeholder culture. In consequence, this new strategy primarily required to forecast and estimate the company’s future earnings and financial needs.

While prepared for forecasting for the next three years for the Body Shop, two methods was used, they are T-accounts forecasting and percentage-of-sales forecasting. In the first method, it was a must to start with a base year of financial statements, like the last year. On the other hand, the percent-of-sale method started with forecasting the sales then the other financial statement accounts based on some presumed relation between sales and that account.

Below is the forecasting for the Body Shop for the next three years (2002, 2003, and 2004)

Income Statement Assumption 2002 2003 2004
Sale (Turnover) 13% 422.7 477.7 539.8
Cost of sales 40% of sales 169.1 191.1 215.9
Gross profit 253.6 286.6 323.9
Operating expenses 52% of sales 219.8 248.4 280.7
Interest expenses 6% of debt 3.4 4.1 4.8
Profit before tax 30.5 34.2 38.4
Tax 30% of PBT 9.1 10.2 11.5
Profit after tax (net income) 21.3 23.9 26.9
Dividends Fixed 10.9 10.9 10.9
Retained earning 10.4 13.0 16.0
Balance Sheet Assumption 2002 2003 2004
Cash Plug 5.1 10 10
Account receivable 8% of sales 33.8 38.2 43.2
Inventories 14% of sales 59.2 66.9 75.6
Current assets 4.9% of sales 20.7 23.4 26.4
Fixed assets 30% of sales 126.8 143.3 161.9
Other assets 1.8% of sales 7.6 8.6 9.7
Total assets 253.2 290.4 326.9
Account payable 4.2% of sales 17.8 20.1 22.7
Tax payable 2% of sales 8.5 9.6 10.8
Accruals 3.7% of sales 15.6 17.7 20.0
Overdrafts Plug 0.0 16.3 28.0
Current liabilities 4.2% of sales 17.8 20.1 22.7
Long-term liabilities Fixed 61.2 61.2 61.2
Other liabilities 0.1% of sales 0.4 0.5 0.5
Shareholders’ equity 132.0 145.0 161.0
Total liabilities and equity 253.2 290.4 326.9

Question Two:

How much debt financing will the Body Shop need over this forecast period? What are the key drivers of this need, and how much do debt needs vary as the assumptions vary?

 

Forecasting is performed by using the assumption that there will be a steady sales growth rate by 13%. Basics of the assumptions used are that the latest company sales growth is 13% and it’s believed that the company will always be in this stable position for the forecast Ed period. The key drivers assumed are sales growth, COGS, and Cash requirement and Long term financing requirements. These assumptions are very important because they are the key component of financing requirement calculation. The company income statement and balance sheet of 2001 reflects the company long term liabilities standing at $61.2 million, and are forecast ed to be same in next years. Meantime, the company cash requirements can be easily matched with company existing cash balance of $13.7 million, but still if the company wish to maintain the stability and level of cash liquidity company needs to inject $20.6 million and $36.6 million, in 2003 and 2004 respectively. To figure out the debt financing requirement, the liability and asset differential of both years is calculated, and the minimum cash requirement is added to that, and the forecast ed requirement of both years in extracted. As the debt needs are mainly based on the projection of stagnant sales growth, they may increase or decrease in line with increase and decrease of growth rate.

 

Question Three:

What issues does this analysis raise for Roddick?

 

After analyzing the forecast of Roddick for next three years 2002, 2003, 2004. Its identified that as the Sales and cost of sales are both set to increase, along with the handsome increase in Gross profit margins upto the estimate of $324 million (323.9 m), with this a significant decrease in the cash liquidity reserves can also be observed, straight into decline from 1999 to 2004, which is positive as the company is interested to invest into new businesses, having a sufficient cash in hand reflects that the company is not managing the investment portfolio efficiently, but at the time this also reflects that the company cash conversion cycle is declining as the overdraft are increasing in line as well. Apart from this, The Body Shop needs to bealigned that they require debt financing if they are interested in growing the company in upcoming years. As the total assets increased from $249.6million to $324.2 million. From what we have evaluated and suggested that the Roddick should continue with his plan of growing the company. Byinsisting the company to manage the expenses, continuously take opportunities in safe investments while keeping in mind that the company’s account payables don’t increase significantly, which can eventually end up the business in a critical financial position.

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