Forecasting Costs

Forecasting COGS

The cost of goods sold (COGS) includes raw materials, direct labor, and overhead costs used in producing the goods. COGS is directly related to sales and forecasted as a percentage of sales. Historical data on a company’s COGS as a percentage of sales provides a starting point for estimates.

Since COGS is a relatively high cost, a small error in this item can significantly impact the forecasted operating profit. Analysts should consider whether analyzing these costs by segment, product, volume, and price components could improve forecasting accuracy.

Some companies may face fluctuating input costs that can be passed on to customers only with a time lag. Analysts should also consider the impact of a company’s hedging strategy. These strategies are revealed in the footnotes on the annual report.

Competitors’ gross margins can provide a good check for estimating a realistic gross margin, even though differences in business models can complicate direct comparisons.

Forecasting SG&A

Selling, general, and administrative (SGA) expenses have a less direct relationship with a company’s revenue. Certain expenses within SG&A are more variable than others, e.g., selling and distribution expenses have a significant variable component and can be estimated as a percentage of sales. A lesser degree of variability can be found in other general and administrative expenses, such as employee overhead and research and development costs.

To benchmark a company against its competitors, it is imperative to analyze the historical relationship between its sales and operating expenses. This can be used to compare a company’s efficiency and margin potential compared to its peers.

Question

Which of the following is least likely a consideration when forecasting operating expenses?

1. The variability of the cost.
2. Relationship between sales and operating expenses.
3. Tax rate.

Solution

The correct answer is A.

The tax rate is not considered when forecasting operating expenses.

A and B are incorrect. Both the variability of the costs and the relationship between sales and operating expenses are considered when forecasting operating expenses.

Reading 17: Financial Statement Modeling

LOS 17 (d) Demonstrate methods to forecasting cost of goods sold and operating expenses.