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CFA Level I · CFA Level I Exam · Financial Statement Forecasting in Equity Valuation

When forecasting a company's cost of goods sold for a manufacturer whose raw material prices are volatile, which approach is most likely to produce the most reliable forecast?

Modelling input costs and volumes separately from sales growth is most reliable, because it captures the true drivers of cost of goods sold. Using last year's gross margin or an industry operating margin ignores volatile raw material prices and company-specific cost structure.

  1. AHold the gross margin equal to last year's reported figure
  2. BModel input costs and volumes separately from sales growthCorrect
  3. CApply the industry average operating margin to forecast sales

Explanation

Separating input prices and volumes captures the drivers of cost changes, so the forecast reflects commodity movements. Holding last year's margin or using an industry margin ignores company-specific cost drivers and would miss the effect of volatile input prices.

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