The Body Shop International PLC 2001 An Introduction to Financial Modeling Case Solution

1. How did you derive the forecast? Why did you choose the “Base-Case” assumptions that you did?

The forecasts of the income statement and balance sheet elements were calculated based on the assumption that as a result of the operational efficiencies brought about by Gournay, Operational costs will decline slightly. Other than that, the revenue growth and estimates of other expenses based on these expenses will remain the same. 2001 was taken as a base year, revenue and expense estimates were found out by taking data for this year as a base. The revenue growth rate from the year 2000 to the year 2001 was around 13%. Therefore, in order to make the forecast practical and conservative, it was assumed that the revenue growth rate from the year 2002 onwards will stay at 13% for the foreseeable future. However, due to the cost-cutting measures brought by the new CEO, it is reasonable to decrease the estimate of the operational costs a percentage of sales to 50% instead of 52.3% in the year 2001. However, an estimate of the cost of goods sold is kept at the same level for the next three years as it was in the year 2001 i.e. 40%. Furthermore, the tax rate for all three years has been assumed to remain at around 30%. Further, interest expense has been assumed to remain at 6% of the outstanding debt amount for all the years to come.

Accounts receivable estimate has been kept at the same level as it was the base year i.e. 8% of the sales. Similarly, inventories, net fixed assets, other current assets, and other assets have been kept at the same ratios relative to sales as they were in the base year 2001. Similarly, all the elements of the liability side of the balance sheet have been kept at the same level relative to sales for the years 2002, 2003 and 2004. These assumptions have been kept at the same level despite structural reforms to keep the forecasted results comparable and practical.

2. Based on your pro forma projections, how much additional financing will The Body Shop need during this period?

External financing needs for a particular year can be calculated by subtracting the capital expenditure needs and the working capital needs of that particular year from the profit retained after paying out the dividends. This is because after the dividends have been paid out to the shareholders, the company needs to invest in working capital and the fixed assets to meet the needs of growth. Cash, Accounts receivable, Inventory and other current assets for a particular year have been added together to find out the total current assets of the company. Similarly, Accounts payable, Taxes payable, Accruals, Overdrafts and other current liabilities have been added to find out the total current liabilities for a particular year. All of these calculations can be seen in the “forecasting” sheet of the excel file. Current assets are then subtracted from current liabilities to find out working capital. Furthermore, Capital expenditure needs for a particular year can be found out by subtracting the Net Fixed asset value of the previous year from the Net fixed value of the current year.

Therefore, working capital needs for the next three years come out to be $65.37 million, $68.193 million and $72.962 million. Similarly, Capital expenditure needs come out to be $16.22 million, $16.487 million and $18.632 million for the next three consecutive years. After carrying out these calculations, it can be seen that external financing needs come out to be $65 million, $64.43 million and $67.137 million for years 2002, 2003 and 2004 respectively.

3. What are the three or four most important assumptions or “key drivers” in this forecast? What is the effect on the financing need of varying each of these assumptions or down from the base case? Intuitively, why are these assumptions so important?

One of the most important assumptions in these calculations is the growth rate of revenue for the next three years. In order to keep the estimate of the revenue conservative, it has been assumed that the revenue growth rate will remain at 13%. Furthermore, another very important assumption is that dividends will remain constant for the next three years i.e. $10.9 million.