Question

Forecasting Example: Assume you own a retail store that sells everything in it for $1. Last year you sold 100,000 items so your revenue was $100,000. The average cost to obtain merchandise was $0.60 per item. What was your Gross profit margin last year? Gross profit margin last year You also spent $25,000 on advertising, rent and insurance(operating costs). What was your operating profit margin last year? Operating profit margin last year = You spent $3000 on interest expense last year and were in a 20% tax bracket. What was Net Income last year in dollars? Net Income = $ What was your Net Profit Margin last year If you have 1000 shares outstanding, what is the EPS reported for last year? EPS last year = 5 Scenario A) This year you are forecasting 6% increase in items sold. The average cost to obtain merchandise is forecast to go down to $0.58 per item for next year but you are not going to lower your prices (still $1). What will happen EPS next year if you still spend $25,000 on operating costs, 53,000 on interest expense and are in a 20% tax bracket? Assume that shares outstanding are still 1000 Forecasted EPS next year = $ Why is it higher next year? Compare Gross margins, operating margins and net margins forecasted for next year to last year. Scenario B) This year you are forecasting 6% increase in items sold. The average cost to obtain merchandise is forecast to go up to $0.63 per item for next year but you are not going to raise your prices (still $1). What will happen EPS next year if your operating costs goes up to $28,000, you spend $3.000 on interest expense and are in a 20% tax bracket? Assume that shares outstanding are still 1000 Forecasted EPS next year = $ Compare Gross margins, operating margins and net margins forecasted for next year to last year under scenario B.

Answer 1

Particular	Year 1
Sales	100000
Revenue	$ 1,00,000.00
COGS	$     60,000.00
Gross Profit	$     40,000.00
Operating cost	$     25,000.00
Operating profit	$     15,000.00
Interest	$       3,000.00
Profit before tax	$     12,000.00
Tax	$       2,400.00
Net Income	$       9,600.00
Share outstanding	1000
EPS	$               9.60

Formula Used

Gross Profit = Sales - Cost of Goods Sold

Operating profit = Gross Profit - Operating cost

Profit before tax = Operating profit - interest

Tax = 0.2*Profit before tax

Net Income = Profit before tax - Tax

EPS = Net Income/Number of shares outstanding

Gross Profit margin = Gross Profit/Sales = 40000/100000 = 40%

Operating Profit margin = Operating Profit/Sales = 15000/100000 = 15%

Net Profit margin = Net Profit/Sales = 9600/100000 = 9.60%

For scenario A).

New Profit and Loss Statement will look like

Particular	Year 1	Year 2 Scenario A
Sales	100000	106000
Revenue	$ 1,00,000.00	$         1,06,000.00
COGS	$     60,000.00	$            61,480.00
Gross Profit	$     40,000.00	$            44,520.00
Operating cost	$     25,000.00	$            25,000.00
Operating profit	$     15,000.00	$            19,520.00
Interest	$       3,000.00	$               3,000.00
Profit before tax	$     12,000.00	$            16,520.00
Tax	$       2,400.00	$               3,304.00
Net Income	$       9,600.00	$            13,216.00
Share outstanding	1000	1000
EPS	$               9.60	$                     13.22

Sales increased to 100000*1.06 = 106000

But COGS has reduced to 0.58 per unit

Gross Profit margin = Gross Profit/Sales = 44520/106000 = 42.00%

Operating Profit margin = Operating Profit/Sales = 19520/106000 = 18.42%

Net Profit margin = Net Profit/Sales = 13216/106000 = 12.47%

New Forcasted EPS = 13.22

EPS has increased because of the increase in sales and reduced cost of goods.

Similarly, Gross Profit margin, Operating profit margin and Net profit margin has also increased.

Scenario B

New Profit and Loss Statement will look like

Particular	Year 1	Year 2 Scenario B
Sales	100000	106000
Revenue	$ 1,00,000.00	$         1,06,000.00
COGS	$     60,000.00	$            66,780.00
Gross Profit	$     40,000.00	$            39,220.00
Operating cost	$     25,000.00	$            28,000.00
Operating profit	$     15,000.00	$            11,220.00
Interest	$       3,000.00	$               3,000.00
Profit before tax	$     12,000.00	$               8,220.00
Tax	$       2,400.00	$               1,644.00
Net Income	$       9,600.00	$               6,576.00
Share outstanding	1000	1000
EPS	$               9.60	$                       6.58

Sales increased to 100000*1.06 = 106000

But COGS has increased to 0.63 per unit

Gross Profit margin = Gross Profit/Sales = 39220/106000 = 37.00%

Operating Profit margin = Operating Profit/Sales = 11220/106000 = 10.58%

Net Profit margin = Net Profit/Sales = 6576/106000 = 6.20%

New Forcasted EPS = 6.58

EPS has decreased because of the increase in cost of goods and operating cost.

Similarly, Gross Profit margin, Operating profit margin and Net profit margin has also decreased.