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Kretsmart anticipates its sales will grow by 10% each year for the next two years. Information from the company's current income statement is given below, and Cost of Goods Sold (COGS) is assumed to be a spontaneous account.
What would the company's projected gross margin for Year 2?
When sales grow and cost of goods sold (COGS) is assumed to be a spontaneous account, COGS increases proportionally with sales. In the current year, Kretsmart's gross margin ratio is calculated as Gross Margin Sales = $55 $100 = 55%, while COGS represents 45% of sales.
Sales are projected to grow by 10% per year for two years. Therefore, projected sales for Year 2 are:
$100 1.10 1.10 = $121.00.
Since COGS remains 45% of sales, projected COGS for Year 2 equals:
$121.00 0.45 = $54.45.
Gross margin is then calculated as:
$121.00 $54.45 = $66.55.
Financial management forecasting techniques commonly use percentage-of-sales assumptions for spontaneous accounts such as COGS, inventory, and receivables. This method allows managers to project future income statements consistently with expected growth. Option B ($66.55) correctly reflects the projected gross margin for Year 2 under these assumptions.