1. Financial analysis and forecasting
Advanced Managerial Finance
Spring 2013

2. Financial analysis and forecasting The Body Shop International
Why would the company want to forecast?
Finance is concerned with expected performance
The value of any asset is equal to…
Investors forecast to value and invest.
“ImmunoMedics reports Q1 EPS (7c) vs. consensus (9c)”
Financial managers forecast to plan and finance

3. Motives for modeling
Decision makers wrestle with risk and uncertainty about the future.
Financial modeling can help to:
measure risk
identify strengths and potential problems
consider the implications of alternative choices
provide the means for a firm to express its goals and priorities
assist the firm in identifying the asset requirements and needs for external financing
sensitivity analysis

4. The Body Shop International
Role of adviser to Anita Roddick, the managing director
You must prepare a three-year forecast of the firm’s income statements and balance sheets
Percentage-of-sales forecasting method
“A Financial Forecasting approach which is based on the premise that most Balance Sheet and Income Statement Accounts vary with sales. Therefore, the key driver of this method is the Sales Forecast and based upon this, Pro-Forma Financial Statements (i.e., forecasted) can be constructed and the firms needs for external financing can be identified”.

5. The Body Shop International
Limitations
because economic climate and demand can change or deteriorate over time, problems start to arise when applying assumptions of the past to the present or future using the percentage of sales forecasting method
assumes that you are always operating at full capacity. It doesn't take into account fixed costs in the event of underutilized resources - it instead assumes everything scales evenly up or down with sales

6. The Body Shop International
Background of the case
Mid 1990’s revenues grew by 20%
Late 1990’s revenue growth slowed down to 8%
Change of management in 1998
Anita Roddick out and Patrick Gournay in
Despite the change problems persisted
In 2001 revenues grew 13 percent
Pretax profit declined 21 percent

7. The Body Shop International
Background of the case
New CEO developed the following strategy
Enhance firm’s brand through a focused product strategy and increased investment in stores.
Achieve operational efficiencies in out supply chain by reducing product and inventory costs
Reinforce our stakeholder culture

8. The Body Shop International
Financial Forecasting
T-account forecasting
Select a base year
Determine how each account will change
What will the new balances be?
Method is cumbersome and requires detailed information
Percentage-of-sales forecasting:
Start with a forecast of sales
Estimate the other accounts based on a predetermined relationship between sales and that account. For example:
Operating margin =

9. The Body Shop International
Percentage-of-sales forecasting (cont.)
Simple to execute
Can be misused. For example:
Financial analysts assumes operational capacity can increase in fractional amounts parallel to increases in sales, but airlines cannot buy just half an airplane.
Use a hybrid system of T-accounts and Percentage-of-sales forecasting
T-accounts for fixed assets and equity
Percentage-of-sales for CA, CL, taxes, etc.

10. The Body Shop International
A pencil and paper forecast (page 121)
Let’s work on Income statement and Balance sheet sections
Iterate section:
The balance and the income statement depend on each other
Interest expense is needed to estimate retained earnings
Retained earnings is needed to estimate debt
Circularity or “which came first? The chicken or the egg” problem.
Problem is solved with iterations, easily done with Excel.

11. The Body Shop International
Negative debt = excess cash
Trial balance sheet line items