RUNNING HEAD: THE BODY SHOP CASE

BNFN 4304 – Financial Policy

Instructor: Mr. Masood Aijazi

Done by: Nour Noureldin Abdul Aziz,

Maryam Barifah, Shrouq Al-Jaaidi, Balqees
Mekhlafi
ID#:1420149, 1420023, 1420072, 1420231
Due: 13th February, 2018
THE BODY SHOP CASE

Table of Content

Executive Summary.................................................................................................................3
Introduction..............................................................................................................................3
Question 1.................................................................................................................................4
Question 2.................................................................................................................................9
Question 4...............................................................................................................................13
Question 5...............................................................................................................................14
Methods of forecasting;.......................................................................................................15
Calculation...........................................................................................................................15
Question 6...............................................................................................................................16
Conclusion...............................................................................................................................17
Recommendation....................................................................................................................18
THE BODY SHOP CASE

THE BODY SHOP INTERNATIONAL PLC 2001:

AN INTRODUCTION TO FINANCIAL MODELING
Guidance Sheet

Synopsis and Objectives

In this case, the student is cast in the role of adviser to Anita Roddick, the managing
director of the Body Shop. The student must prepare a three-year forecast of the firm’s
income statements and balance sheets. The case is intended to introduce percentage-of-sales
forecasting and walks the student through the preparation of a simplified forecast, first using
pencil and paper, then using a spreadsheet program on the personal computer. The case
emphasizes the importance of being able to speak plainly about one’s financial forecast and
the insights that are of use to the general manager.

Instructions to Students

Work through the exercises in this case, first using pencil and paper, and then using
your personal computer. Then follow the directions in the case to make the three-year
forecast, and prepare responses to the questions posed at the end of the case.

The Microsoft Excel spreadsheet file, UVA-F-1349X, supports student analysis and saves a
few keystrokes in formatting and entering data for the final exercise of the case.

Questions:

1. Why would a company like the Body Shop want to forecast its financial statements?
Let us vault past the exercise questions and go straight into the three-year forecasts:
How did you prepare your forecast and what numbers did you get?

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?

3. What issues does this analysis raise for Roddick?

Note: A spreadsheet is provided but students are free to create their own analysis, financial
models, and projections etc. Please provide all supporting data and schedules.
THE BODY SHOP CASE

Executive Summary

In the late 1990s The Body Shop International PLC was viewed as one of the fastest

emerging skin and hair-care manufacturer-retailers in the world. The company was initially

founded by Anita Roddick who stepped down as CEO (chief executive officer) in the year

1998. In 2001 Patrick Gournay who took over the position of CEO, decided to implement a

new strategy which will consisted of three objectives: 1) to enhance the brand through a

focused product and increased investment in stores, 2) to achieve operational efficiencies in

the supply chain by reducing product and inventory costs, and 3) to support the stakeholder

culture. In the mid 1990s the company annual revenue growth rate was 20% however this rate

later dropped to 8% due to the intense rivalry that appeared in the late 90s.

This case is about forecasting the financial position of The Body Shop which is done

by projecting the financial statements of the company for the next three years (2002 till

2004). The two methods that will be used are T-account forecasting and Percentage-of-sales

forecasting.

Introduction

In 1998, both Roddick and Gournay had thought of multiple ways to strategize the

company. However, many problems kept on persisting despite the change in management and

the damage that was already done. Revenues kept on a steady growth of (13%); however, pre-

tax profit seemed to still decline in the years following. By 1999, the company would have

spent GBP 4.5 million to close their shops that were unprofitable and reviewing the rest of the

shops in the United States. In addition to that a loss of GBP 2.4 million in 2001 was incurred

on supply chain development. Therefore, in the spring of 2001, Anita Roddick, the founder

and co-chair of the board of directors, and Patrick Gournay CEO, asked for help with

estimating the shops financial needs and future earnings. This is also due to the fact that

Roddick lacked a background in finance, although she very good at making strong decisions.
THE BODY SHOP CASE

Question 1

How did you derive your forecast? Why did you choose the base case assumptions that

you did?

The forecast used was derived by looking at the historic financials shown in the case

in Exhibit 8 but also taking into consideration the company’s objectives mentioned both in

the case and above. Therefore, to prepare our forecast for the years (2002-2004), it was

decided to use a hybrid of two main financial forecasting methods: T-account forecasting and

a Percentage-of-sales forecasting. T-account will start with a base year of financial statements

(2001) and is used to estimate future shareholders’ equity as well as fixed assets. The other

side, percentage-of-sales starts with a forecast of sales which will the estimate every accounts

relationship and its sensitivity to sales and it is used to estimate income statements, current

assets and current liabilities since they are affected by sales. Using this method, we were able

to get a forecasted balance sheet and income statement (found in the excel sheet). There is

also a sensitivity analysis which was also prepared where varying inputs are inserted in order

to visualize the effect that the variation of revenue growth and cost of goods sold on debt.

Below is an explanation for the calculations and forecasting done for each account:

1. Sales: There is a shown increase in the ratio from 1999 (£ 303.7 million) to 2001 (£

374.1 million), this can be due to the increase in efficiency done by the new CEO

Gournay who stepped in that year and started restructuring the company. Thus, the

turnover increases every year. So using this information an assumption was made that

the percentage which was stated in the case for 2001 (13% growth rate) is the one that

should be used to forecast the sales (turnover) for the future sales (2002-2004), this rate

is rate is taken since the company is implementing a new strategy and hopefully

improve their sales in the future.

2. Cost of Goods Sold (COGS)/Sales: The following ration had a small fluctuation in

the previous 3 years as it decreased from 42% in 1999 to 39.8% in 2001. Therefore an
THE BODY SHOP CASE

assumption was taken that it will stay constant throughout the forecasting years (2002

till 2004). The estimated average taken was equal to 40%, which used for the future 3

years.
3. Operating Expenses/Sales: This ratio has been increasing throughout the past three
years and it is a key driver for the pre-tax profit decline during the sales growth in

2001. The trend shown in the previous financial statements shows an upward pattern

therefore, we didn’t use an average of the previous three years, what was taken was

the most recent year since the assumption was made that The Body Shop will be able

to keep that same ratio in 2001 (52.3% ≈ 52%) for the next three years (2002-04).

Although the company strategy focused on enhancing their operational efficiencies, the

assumption made is that operating expenses excluding exceptional costs/sales ratio will

not decline for the three years forecast.

4. Exceptional costs and Restructuring costs: since the company’s business strategy is
to achieve operational efficiencies in their supply chain, there will be both exceptional

and restructuring costs for the forecasted years. However it is not fully known if the

company will follow this plan also, there is an uncertainty when projecting external

aspects that will affect the company so it was better to not include these numbers in the

projections.
5. Interest expense: If the debt (plug) is negative then interest is earned at a rate of 6%.

This 6% rate is the one that was used when assuming the 2002 till 2004 forecast which

was taken directly from the book from Exhibit 1.

6. Tax Rate: the rate that was used for the three years’ forecast is 30% tax rate which is

taken directly from the case from Exhibit 1.

7. Dividends: when looking at the historical financial statement, it was observed that the

dividends were the same every year, therefore the assumption was that the same
THE BODY SHOP CASE

figure during the forecasts which is an amount of £ 10.9 million dividends. This is

because it is believed that the company’s dividend policy will be the same for all the

years.

8. Cash: when looking at the balance sheet it shows that the cash has decreased from

year 1999 to year 2001, and it is assumed that this trend will continue for the

upcoming years (2002 to 2004).

Every account in the assets accounts below were measured as a percentage of sales taken

from the most recent year in the historical financial statement.

9. Accounts receivable: Using the sales percentage for this account where the most

recent year (2001)’s figure equal to 8.1% was taken, so the forecasts is approximately

8% for the 2002 till 2004.

10. Inventories: this account is increasing in the past three years and it is assumed to

increase for the next three years due to the business strategy stated by the company.

Therefore, the most recent years’ value (13.7%) was taken from the historical data and

applied it to the forecasted years.

11. Other current assets: this ratio is assumed to remain constant at 4.7% based on the

most recent historical data and there will be no increase in the percentage of sales for

this account as what was previously there was utilized efficiently.

12. Net fixed assets: The company’s strategy which is to increase their investments in

stores, this account is assumed to increase every year. This will be shown from the

previous years, it was chosen to take the most recent years’ percent of sales which is

26.9% for 2001 so respectively it will be 30% for the next three years.
THE BODY SHOP CASE

13. Other Assets: for this account, what was used was the most recent years’ value based

on historical data which is 1.8% which is used for the three forecasted years. What

could also be used was the weighted average since in year 1999 this account was 0%

1.8 +1.8
and in 2000 and 2001 it was 1.8% which will give the same amount of (
2

)= 1.8%.

14. Accounts payable: Due to the upward trend from year 1999 to 2000 and then

downward trend from 2000 to 2001, it was decided to grow the percentage in the

future years by 4%. The same result can be obtained from calculating the average of

4.3+6.2+2.9
the three historical years ( )=4.46% approximately 4%.
3

15. Taxes payable: it is assumed that this account will stay at the current percent-of-sales

level from year 2001 equal to 1.9% approximately 2%. Therefore, the assumption is

based on taking the value of the most recent year.

16. Accruals: is equal to the weighted average of the percentage of sales ratio in the past

3.6 + 4.7 +3.1

three years = 3.8% of sales each year. However, 3.5% of sales was
3

used each year because there was an upward trend followed by a downward trend,

therefore, in order for the total assets to be equal to the total liabilities and equities a

3.5% would be the most suitable rate to use.

17. Overdrafts: this account is linked to the excess cash and it is the difference between

trial liabilities and trial assets. Any shortfalls in liabilities from assets were covered by
THE BODY SHOP CASE

increasing overdrafts which makes it a plug. This account is also affected by the

minimum cash balance because it acts as the source of financing for the cash balance.

18. Other current liabilities: based on the historical data it was observed that there was

a downward trend from 1999 to 2000 followed by an upward trend from 2000 to

2001, therefore, a 4% of sales was used for the next three years as the aim was to try

to shrink the percentage for the future.

19. Long term liabilities: for this account a fixed number was taken from the most

recent year (2001) £ 61.2 million, which is going to be constant for the next three

years.

20. Other liabilities: this is assumed to stay at its level of 0.1% in 2001 throughout the

years 2002 to 2004.

21. Shareholder’s equity: for this account, it was better to use the T-account method

where it is assumed that the shareholders’ equity for the forecasted years is equal to

the previous year’s shareholders’ equity plus this year’s retained earnings. For

example, for 2002 its equal to (£ 121.6 million+ £ 10.40 million) which gives an

amount of £ 132 million in the shareholder’s equity. As for 2003 (£ 132 million + £

13.07 million = £145.14 million) and for 2004 (£ 145.14 million + £16.07 million = £

161.20 million).

 The base case assumptions that was done and chosen when deriving the pro

forma financial statements were critically important. These assumptions are

derived directly from the company itself while also keeping in mind the strategy

that was proposed by Patrick Gorunay. After determining the amount of sales for

the next three years, the first base case assumption that was chosen is cost of
THE BODY SHOP CASE

goods sold (COGS) due to its direct relationship with sales and its effect on

profits. The second base case is operating expenses as the costs incurred are

independent of the level of sales produced. The other assumptions for the base

case are mentioned above in details.

 The plug: debt (excess cash) in the case was determined by the difference between

trial assets and trial liabilities as to make the two sides of the balance sheet to

balance. This was prepared to ensure the company always had sufficient cash on

hand for it to cover any short-term payments related to growth or opening new

stores.

Question 2

Based on your pro forma projections, how much additional financing will the Body

Shop need during this period?

Table for Growth Forecast:

2002 2003 2004
Sales growth 13% 13% 13%
COGS/Sales 38% 38% 38%
Operating expenses 50% 50% 50%
Interest rate 6% 6% 6%
Tax rate 30% 30% 30%
Dividends 10,900 million 10,900 million 10,900 million
Current assets/sales 32% 32% 32%
Current 28% 28% 28%
liabilities/sales
Fixed assets 110,600 million 110,600 million 110,600 million
Starting equity 121,600 131,999 144,989

Net Working Capital Projections (Numbers in Millions):

2002 2003 2004

Trial assets 245,875 263,460 283,332
Trial liabilities and 265,395 296,321 319,595
equities
Plug: Debt (Excess -19,520 -32,900 -36,262
cash)
Excess Cash +19,520 +32,900 +36,262
THE BODY SHOP CASE

As shown above, NWC (Net Working Capital) is increasing over the forecasted time

period. Based on the results above the Body Shop shouldn’t have to worry about getting

additional financing because in 2004 it is shown that they will have excess cash. The

company is shown to have strong financing and therefore will not have to borrow money

from any external sources to run their business activities.

Nevertheless, in order to calculate the external financing needed the below formula

can be used:

EFN= (

Assets Spontaneous Liabilities

x x ∆ Sales−Profit Margin x Projected Sales x ( 1−d ) ¿ .
Sales Sales

However, this formula is only used when all the required data for the full cash flow

analysis is not available (not having enough information), which is not applicable in this case.

Therefore, to know how much additional financing is needed the detailed cash flow

projections were taken from the three years forecast in the Excel Sheet. The forecast reveals a

financing need (overdrafts) of £14.99 million in 2003 and £26.40 million in 2004. However,

when adding the plugs for the forecasting period (2002-2004) the debt that is required is

equal to £45.14 million pounds (3.75+14.99+26.40).

Question 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 up or

down from the base case? Intuitively, why are these assumptions so important?

The most important assumptions in this forecast are used in order to enhance The Body

Shop brand through a focused product strategy and increased investment in stores; to achieve

operational efficiencies in the supply chain by reducing product and inventory costs; to
THE BODY SHOP CASE

reinforce the stakeholder culture, and to keep production costs optimally under 40% with the

assumption that the growth rate will continue at 13%. These are all complying with the

objectives of the company.

Exploring sensitivity analysis on the future years will help in seeing how variations in the

forecast assumptions will affect the financing requirements. The most important assumptions

are:

Sales growth equal to 13% per year in the base case. Cost of Goods Sold (COGS)/sales ratio

equal to 40% per year in the base case. Operating expenses/sales which is equal to 52% in the

base case. Current Assets/Sales ratio and Current Liabilities/Sales ratio are used as key

drivers to determines the Net Working Capital (NWC).

1. Turnover ratio increases over the years due to the increase in efficiency which was

brought on by the new CEO (Gorunay). Sales growth is the most important

assumptions due to the fact that all of the other accounts are all sensitive to any

changes that will happen, since they are all based on it. Sales growth has as well a

very close relationship with the company’s financing plan. Sensitivity analysis 1

shows when sales increases, the excess cash increases as well, therefore, there is a

direct relationship between sales and excess cash. Intuitively, if a company wants a

bigger growth, it will need more funding to expand and reach that growth target. That

is the reason why they are required to keep the sales growth between 11-15% where it

was preferred to choose a steady sales growth of 13% for the years 2002 till 2004.
2. Cost of sales was 42% in 1999, 36.2% in 2000, and 39.8% in 2001. Due to the intense

competition that the Body Shop started facing an assumption was made where their

cost of sales percentage should not go above 44% and they must at least maintain it

from 40 to 41% to make sure that they don’t go over their cost limit. When looking at

the Excel Sheet “Sensitivity Analysis 1.1” it shows that the COGS that is less than

44% requires funding through excess cash while above 44% meaning at 45% and
THE BODY SHOP CASE

above it requires external financing in the form of debt.

3. The effect of varying the growth operating expenses from the base case (52% per

year) is shown in “Sensitivity Analysis” in the Excel Sheet. The analysis shows that

operating expenses rate at 50% or less requires funding through excess cash while

above 50% “at 60% and above” it would require external financing in the form of

debt. As operating expenses increases the debt of the company increases as well.
4. The sensitivity analysis indicates the current assets/sales ratio where if it is less than

40%, then it requires financing in the form of excess cash whereas at 40% rate or

more it would require external financing in the form of debt.

5. The sensitivity analysis shows the current liabilities/ sales ratio where if the rate is

above 20%, then the Body Shop would need external financing in the form of excess

cash. At growth level at or below 20%, it would need funding in the form of debt.
 These assumptions are very crucial because the first three are significant drivers of

the Body Shops operational expenses while the second two are significant drivers

of the financial expenses.

Input Data
Sales 500
COGS 45%
Dividends 60%
100
Expenses (adding new facility) M
Current Assets 40%
Accounts Receivable 28%

The input data above is taken directly from the case. Therefore, based on the above

table, the effect of these sensitivities on both the balance sheet and the income statement

shows that when increasing the sales in 2002 this will further increase both the cost of goods

sold and the gross profit, however decreasing operating expenses. Increasing COGS by 45%

will increase the gross profit as well. In addition, when increasing dividends this will

eventually decrease the retained earnings. Adding more expenses like adding a new facility
THE BODY SHOP CASE

will as well lower the profit after taxes (Net Income). Moreover, increasing current assets

(inventories and account receivable) will have a positive effect on total assets as it will

increase as well.

Question 4

Why are your findings relevant to a general manager like Roddick? What are the

implications of these findings for her? What action should she take based on your

analysis?

Financial forecasts are very crucial to all companies in order for them to have a clear

picture if they are making enough money to cover all expenditure and obligations they think

is expected from them in future. A forecast may also show if a business is going to need to

keep in the same position that they are in or will they need to start making changes to get a

more optimistic future for the company. While looking over the previous trends it shows the

body shop precisely what has happened and the next step from there is to determine if they

should keep the same trends or not.

The findings that were collated are considered relevant for the founder Roddick

because the final decision lies in her hands, who also doesn’t have a strong background in

finance. Therefore, the findings from these statements are going to help her calculate all

financial ratios needed which is considered an essential step in the decision-making process.

The findings for the forecasted period is going to help give the Body Shop an indication of

the financial position that they will be in for the next couple years, and this can help lead

Roddick and Gorunay to make future decisions based on their business strategy. These

projection can also provide an indication of future investments that will need to happen in

inventories and monitoring that will need to be done on level of costs. A certain level of
THE BODY SHOP CASE

growth will also be needed to continue the company’s recent capital structure that is required

to support the business strategy, these will be all shown in the projections.

Based on the analysis done the action is that Roddick should try to decrease the cost

of sales (COGS), which can be done by increasing manufacturing in other countries where

they can get an increase advantage of economies of scale, since the raw material and cost of

production costs less. This decision can help the Body Shop to compete with lower prices, yet

they will still be able to have an advantage against the current competition. The pro-forma

forecast that was done will show them where exactly additional financing is needed and

where they will be able to get it from. In this case, the required funding will come from

excess cash, therefore, they do not need to contact investors to take a loan.

Question 5

Why would a company like the Body Shop want to forecast its financial statements? Let

us vault past the exercise questions and go straight into the three-year forecasts: How

did you prepare your forecast and what numbers did you get?

Companies like the Body Shop should prefer to forecast their financial statements for

them to get an idea of where the company may stand in the future and for them to be

knowledgeable about any future issues that might arise, thus this can help them to try and

solve them before they become a problem. Even though future events and occasions that

affect business are unpredictable, forecasting is also an important part of business planning

and it is a useful tool to help guide that process of decision making, therefore giving

businesses an edge above their competition.

Forecasting is also an integral part of business since it assists them in case they need to

secure a bank loan or any future funding, so if they see that they have a need for cash in the

future they will be prepared. It is also helpful since any investors or lenders would prefer to

see a forecast to see if the business that they are putting money will be able to repay on time.
THE BODY SHOP CASE

By forecasting businesses are allowed to check whether they are following the right direction

if certain strategies, events and plans are carried out (The importance of Financial

Forecasting, 2013). The Body Shop has been a public company since 1984 and for public

company’s financial statements are used as the main attraction for all potential shareholders.

Financial statements are prepared by estimating the annual growth of revenue which is

13% and then applying this same rate throughout the rest of the statements. Forecasting the

company’s statements is vital to ensure that Gorunay will be able to effectively and

efficiently implement the new strategies mentioned beforehand. Forecasting would help

increase supply chain efficiencies by reducing product and inventory costs and achieve the

other objectives in the strategy as stated in the case.

Methods of forecasting;
When preparing the financial forecast for the next three years (2002-2004) for the

Body Shop by using two different types of financial forecasting: T-account forecasting, which

usually starts with a base year of financial statements (2001) and also Percentage-of-sales

forecasting, which starts with a forecast of sales and then estimates other financial statement

accounts based on a presumed relationship between sales and all other accounts.

The common approach that is used in financial forecasting is a hybrid of both methods.

The T-account method will be used to estimate shareholder’s equity and fixed assets, where

percentage-of-sales forecasting method is used to estimate the income statements, current

assets and current liabilities accounts. The forecasts for the next three years are all shown in

the excel sheet in Exhibit “Forecasts & Pro-Forma”. Below is a table which shows trial

liabilities, assets, plug, minimum cash balance and the plug (debt).

Calculation:

 Trial assets are calculated by adding all the current assets and fixed assets

together.
THE BODY SHOP CASE

 Trial liabilities and equity is calculated by adding all the current liabilities, long-

term liabilities, and shareholders’ equity excluding the overdrafts.

 Trial plug is the difference between trial assets and trial liabilities.

 Minimum cash plug is assumed to be 10 million.

 The last row is calculated by the difference between trial plug and minimum

cash balance.

Trial Assets 247.30 279.45 315.78

Trial Liabilities and Equities 253.55 274.45 299.37

Trial plug (6.25) 5.00 16.40

Min. cash Balance 10.00 10.00 10.00

Plug 3.75 15.00 26.40

Question 6

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 debt financing that the Body Shop will need over the future period (2002-2004) is

approximately 44.92 million pounds in order for the balance sheet to be balanced. As

mentioned earlier, one of the key factors is Cost of Sales. Decreasing Cost of Sales could be

done with increasing the manufacturing in a country where labor wages and material costs of

products are less expensive. Another method would be using the excess cash which could

mean they would not need to obtain new loans. Although it would be easier to cover the

needs through debt, however that could drastically increase the risk associated with it, and

thus increase the chance of bankruptcy. Another key driver is funding through equity. As the
THE BODY SHOP CASE

company grows in size, funding is required more to cover the needs of the company. That

being said, unlike equity, debt must be repaid after some point and it is accompanied with

interest costs. Interest costs increase the risk of insolvency; that is companies that are too

highly leveraged could find it difficult to grow due to the high cost of servicing the debt. The

rest of this question is clearly answered in both questions 2 and 3.

Question 7

What issues does this analysis raise for Roddick?

Based on the forecasted number and the analysis for the years (2002-2004) and the

sensitivity analysis which was conducted. It can be concluded that the Body shop will not

need any further financing if they are able to keep their sales growth at 13% each year and

COGS/Sales at 40%. This can mean that they can operate without having the need to get an

external financing due to the excess cash in their financial statements. Even though operating

expenses increases as well, this is a necessary caution in order for improvements to be made.

Based on the forecasts that the company will have a positive financial situation during the

forecasted period. The key drivers ranking starts with: Sales, then COGS, then Operating

Expenses, then Current Assets and Current Liabilities. However, Roddick can look at other

accounts such as dividends and fixed assets and then make a sensitivity analysis for both to

determine the required financing needed. For being the general manager, Roddick must look

at the sensitivity analysis that was conducted and then choose a percentage for each account

only if it requires financing in the form of excess cash and not debt.

Conclusion

To conclude, this case is about forecasting the financial position of The Body Shop

which is done by projecting the financial statements of the company for the next three years

(for 2002, 2003, and 2004). The data is taken from the historical years in order to project the

forecasted years. Financial analysis and forecasting are vital in order for the company to be
THE BODY SHOP CASE

able to plan and finance for the future. The forecast is done by using the assumption that

steady sales growth is 13% and cost of goods sold(COGS)/sales ratio is 40%. The three years’

forecast was all based on assumptions as shown in the Excel Sheet and the two methods used

were (T-account forecasting and Percentage-of-sales forecasting). The next step was to do the

sensitivity analysis and determine how much debt financing is needed for the projected years.

Overall, the forecasting that was done shows great results for the company.

Recommendation

Based on the analysis, It is recommend that the company should meet the numbers

contained in the projections as it indicates a positive outcome for them. Moreover, they

should also take certain measures such as innovating so that the growth rates will constantly

be at 13% and the COGS/Sales at 40%. Thus the company need to control costs and

operational expenses rate at around 52% while making the improvements in order to avoid

any external financing. Reducing the costs is needed in management, therefore, I believe in

this way the Body Shop International will gradually achieve their objectives through

continuous improvements.