How do you model the impact of a 10% increase in raw material costs on a manufacturing company's P&L, balance sheet, and cash flow statement? Walk me through the key assumptions and linkages.
An advanced FP&A question — expect it in final rounds and case-heavy interviews (IB, PE, Big-4 Transaction Services).
THE SHORT ANSWER
First, identify the direct cost impact: if raw materials are 40% of COGS, a 10% increase raises COGS by 4% (assuming no pass-through). This reduces gross profit and EBITDA. On the balance sheet, inventory (raw materials) increases by the same percentage, boosting current assets but also requiring more cash. The cash flow statement shows lower operating cash flow due to lower net income and higher inventory. If the company can pass on costs via price increases, revenue and receivables also rise, partially offsetting. I'd model scenarios with and without pass-through to show EBITDA and cash sensitivity.
WHAT INTERVIEWERS LISTEN FOR
- ✓Direct cost impact on COGS and gross profit
- ✓Balance sheet effect on inventory and payables
- ✓Cash flow impact from lower net income and working capital changes
- ✓Scenario analysis with price pass-through
COMMON MISTAKES
- ✗Ignoring balance sheet and cash flow effects
- ✗Assuming 100% pass-through without justification
- ✗Not considering timing differences
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