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Question 1: Why would a company like the Body Shop want to forecast its financial statements?

In 1998 Anita Roddick the founder of The Body Shop, resigned from her position, after the ineffective attempts to reaffirm the company. Patrick Gournay was placed as a new CEO with a slight of management change. Moreover, the company was able to increase its revenue by 13% in 2001 while the pretax profit declined by over 21%. Gournay stated, "This is below our expectations, and we are disappointed with the outcome." Gournay had high expectations of implementing a new strategy to improve the company's results. This strategy contained three major basic objectives, which are, to enhance The Body Shop Brand through a focused product strategy and increased investment in stores, and to achieve operational efficiencies in the company's supply chain by reducing product and inventory costs, and to reinforce the company's stakeholder culture. To implement this new strategy efficiently, it was essentially required for Gournay to forecast the company's financial statements. Doing so will lead to an increase in operational efficiencies and lower product and inventory costs.

Question 1 (b): How did you prepare your forecast and what numbers did you get?

I used two different methods of financial forecasting when preparing the financial forecast for the next three years for The Body Shop. The first method is the percentage-of-sales forecasting which is forecasting the sales at first then estimating other financial statement accounts based on some acknowledged association between sales and that account. While the second method is T-accounting forecasting, which requires us to start with a base year of financial statements, such as final years. While knowing that the most used approach of financial forecasting is a hybrid of both methods, as T-accounts are used to predict shareholders' equity and fixed assets, whereas, percent-of-sales forecasting method is used to estimate the income statements, current assets, and current liabilities.

My forecasting for The Body Shop over the next three years (2002-2004) is listed below.

Income Statement

2002

2003

2004

Growth

13%

422.73

477.7

539.8

COGS

40%

169.1

191.1

215.9

Gross- Profit

253.64

286.6

323.9

Operating- Expenses

52%

219.8

248.4

280.7

Fixed

0%

0

0

0

Fixed

0%

0

0

0

Interest

6%

3.79

4.39

5.1

PBT

30.03

33.8

38.0

Tax

30%

9.01

10.15

11.41

NI

21.02

23.7

26.62

Dividends

10.9

10.9

10.9

Retained Earnings

10.12

12.78

15.72

Balance Sheet

2002

2003

2004

0.2

10

10

Accounts Rec

8%

33.8

38.2

43.2

Inventory

13.70%

57.9

65.4

74.0

CA

4.70%

19.9

22.5

25.4

FA

30.00%

126.8

143.3

161.9

OA

1.80%

7.6

8.6

9.7

TA

246.2

288.0

324.2

Accounts Payable

3%

12.7

14.3

16.2

Taxes

2%

8.5

9.6

10.8

Accruals

3.5%

14.8

16.7

18.9

Plug

0.0

22.1

34.8

CL

4%

16.9

19.1

21.6

LTL

Fixed

61.20

61.2

61.2

OL

0.1%

0.4

0.5

0.5

Equity

131.720

144.5

160.22

TL&E

246.2

288.0

314.2

Trial Assets

246

278

314.2

Trial Liabilities

246.2

265.9

298.4

Trial Plug

-0.2

12.1

24.8

Minimum Cash

10

10

10

Plug

9.8

22.1

34.8

Question 2: 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?

The Body Shop's income statement and balance sheet from 2001 prove that the company has zero debt. To put it differently, the company has $13.7 million cash, which can be used to achieve the company's desired cash balance for 2002-2004.

In 2003 the company would need to finance $22.1 million and $32.8 million if the company desires to stabilizes and maintains its desired level of cash as well as, achieve the estimated level of growth. To compute the plug account, the difference between trial assets and liabilities was calculated as well as, the desired amount of cash. Then, added all together. As shown above, the body shop will need to continue to increase its cash to finance its operations.

Question 3: What issues does this analysis raise for Roddick?

When calculating the forecast for the upcoming three years (2002, 2003, 2004) we concluded that the cost of sales and gross profits would continue to increase for the company. As well as, the company's gross profit is forecasted to be almost $324 million, which is almost over 43% from the 2001 gross profit. Not to mention, the severe decrease in cash in 1999-2004, which can also give us a good sign because as mentioned earlier, The Body Shop wanted to begin to invest in other companies, in the hope of growing their company. Having too much cash can be an indicator of having it not used efficiently. The extra cash generated should be used in further potential investment opportunities as well as, from 1999-2004 overdrafts increased significantly as well. Moreover, The Body Shop needs to be aware of its debt financing. As from 2001 to 2004, total assets increased from $320.1 million to $324.2 million. From what we have seen, we advise Roddick to continue with his plan of growing the company. By emphasizing the management of the company's expenses, continually taking opportunities in safe investments while keeping in mind that the company's account payables don't increase rapidly, which can eventually lead The Body Shop to a terrible financial position.