Lesson 2 of 8 · All lessons in this module
- The model's structure and the revenue forecast
- Operating costs, non-operating items and the pro forma income statement
- Forecasting the cash flow statement and balance sheetVideo lesson
- Behavioural biases in analyst forecasts
- Competitive factors: Porter's five forces, prices and costs
- Forecasting sales and costs under inflation and deflation
- Integrated cases: volume shocks, fixed and variable costs and assumption sets
- The forecast horizon and long-term projections
Lesson 2 of 8 · 14 min
Operating costs, non-operating items and the pro forma income statement
Costs are forecast with the driver that fits their behaviour: gross margin for COGS, a percentage of sales for variable overheads, absolute growth for fixed ones; interest, tax and share count then turn EBIT into EPS.
In short
- COGS is usually forecast through the gross margin; a better price/mix tends to raise gross margin.
- SG&A: costs that move with sales (e.g. distribution) as a % of revenue; largely fixed costs (e.g. administration) by growth in the absolute amount, so they fall as a % of sales when revenue grows.
- Volatile, unpredictable items such as other operating income/expense are often forecast at zero.
- Net finance cost = interest on debt − interest income on cash; it needs forecasts of debt, cash and interest rates (fixed, or a reference rate plus a spread if variable).
- Income tax: use an effective rate, e.g. the statutory rate if the effective rate has tracked it. Shares: basic and diluted weighted averages; equity compensation increases shares, buybacks reduce them.
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