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Case Study: Predicting Cost of Goods

April 13, 2006

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This example looks at predicting the cash outflows in the cost of goods sold category in order to prepare a cash flow budget. A cash outflow falls under this category if it is for the purchase of inventory items resold to your customers or for inventory items used to manufacture an end product.

Scott Derby owns a store called the "Top Hat." His store specializes in selling - you guessed it - hats! Scott purchases all his hats from special hat suppliers and resells them to his customers.

Scott is preparing a cash flow budget for the first six months of 2001, and needs to predict his cost of goods sold to complete the budget. To determine his cash outflows for the budget, Scott will use the sales and cost of goods sold information listed on his tax returns from the previous four years. Using this information allows Scott to determine the percentage relationship between sales and the cost of goods sold.

The following chart summarizes the information from his tax returns, and shows the cost of goods sold percentages for the previous four years:

From the information listed above, Scott has determined that his cost of goods sold has been averaging about 59.95 percent of his total sales over the last four years. Scott will use this percentage to predict his cash outflows for the six month cash flow budget he is preparing for 2002. In his budget he will assume that his cash outflows for the cost of goods sold will continue to average about 59.95 percent of his forecasted sales. The following chart summarizes his budgeted cash outflows for the cost of goods sold.

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