Updated for the 2026-2027 CFA® Level I curriculum.
When prices are rising or falling, you cannot forecast sales and costs with a single growth rate. Revenue growth reflects both how much a company sells and what it charges. Cost growth reflects both how much it buys and what it pays. The CFA Level I curriculum tests whether you can separate these effects and judge how inflation or deflation changes a company's margin.
Quick Answer
Forecasting sales and costs under inflation or deflation means separating price changes from volume changes, then checking whether a company can pass cost increases through to customers. Nominal sales growth reflects both volume and price. Margins depend on whether cost inflation matches price inflation. Under deflation, falling prices can shrink revenue even when volume grows, so analysts should model price and volume separately.
Key Takeaways
Nominal sales growth combines volume growth and price growth. Model them separately when prices are not stable.
A company's pricing power determines whether it can pass cost inflation through to customers and protect margins.
When input cost inflation outpaces price increases, margins compress even as nominal sales rise.
Under deflation, falling prices can offset volume gains, producing weak or negative nominal revenue growth.
Contractually fixed costs do not automatically adjust with the price level during the relevant period, so deflation raises the fixed cost burden as a percentage of sales.
Match inflation assumptions across revenue and cost line items so the forecast stays internally consistent.
What You Need to Know for CFA Level I
The LOS asks you to explain, not to build a full model. Focus on the reasoning, not heavy calculation.
The core concept is decomposing sales growth into a price component and a volume component, then applying the same logic to costs.
You need to compare pricing power across companies to judge whether cost inflation hurts margins.
This page does not cover why a company has pricing power. That belongs to Porter's Five Forces and Forecasting Prices and Costs.
The main trap is assuming inflation automatically helps revenue without checking what happens to costs at the same time.
What Changes When Prices Are Not Stable
A simple trend forecast assumes last year's growth rate repeats. That assumption breaks down when inflation or deflation is material, because part of last year's growth came from volume and part came from price. If inflation accelerates or decelerates, the price component of growth changes even if volume behavior stays the same.
The same logic applies to costs. A company's cost of goods sold moves with the volume of units produced and the price of inputs like labor, materials, and energy. Forecasting costs accurately means tracking both pieces, not just last year's percentage of sales.
Decomposing Sales Growth into Price and Volume
The cleanest way to forecast sales under inflation or deflation is to separate the two drivers and combine them multiplicatively.
where:
: forecast nominal sales growth rate,
: forecast unit or quantity growth rate, and
: forecast average selling price growth rate (inflation or deflation in output prices).
For small growth rates, the two components roughly add together. At the growth rates tested on the exam, use the multiplicative form so the answer is exact.
The same structure applies to cost of goods sold, replacing volume growth and price growth with unit growth and input cost inflation.
where:
: forecast growth rate in cost of goods sold,
: forecast unit or quantity growth rate (same volume driver as sales), and
: forecast growth rate in the price of inputs.
Forecasting Costs Under Changing Price Levels
Input costs rarely move at the same rate as output prices. A manufacturer's raw material costs might inflate at 7% while the company can only raise selling prices by 3%. That gap, not the inflation rate alone, drives the margin outcome.
Fixed costs behave differently from variable costs in this setting. Fixed costs like rent or depreciation do not automatically rise with inflation unless a contract calls for an adjustment. Under deflation, this means fixed costs stay level while revenue falls, so they consume a larger share of sales. Variable costs tend to track input price inflation more closely because they are tied to units produced.
Pricing Power and the Margin Outcome
Whether inflation or deflation helps or hurts margins depends on pricing power, defined here simply as the ability to pass cost changes through to customers.
Scenario | Strong Pricing Power | Weak Pricing Power |
|---|---|---|
Inflation | Selling prices rise with input costs. Margin holds steady. | Input costs rise faster than selling prices. Margin falls. |
Deflation | Selling prices fall with input costs. Margin holds steady. | Selling prices fall faster than input costs. Margin falls. |
Notice the pattern repeats in both directions. The direction of the price level change (inflation or deflation) matters less than the relative speed of price changes versus cost changes. This is the core analytical point tested at Level I.
Working Example
An industrial parts manufacturer reports base year revenue of $500 million. COGS is $300 million, or 60% of revenue. Assume COGS is entirely variable, production equals sales volume, input use per unit is unchanged, and no inventory cost-flow lag affects recognition.
Forecast assumptions for next year:
Unit volume growth: 3%
Selling price inflation: 2% (limited pricing power)
Input cost inflation: 6%
Step 1: Forecast sales growth
Nominal sales growth is 5.06%. Forecast revenue is:
Step 2: Forecast COGS growth
COGS growth is 9.18%. Forecast COGS is:
Step 3: Compare gross margins
Revenue grows and the company looks healthy on the top line. But because input cost inflation outpaces the company's ability to raise prices, gross margin falls by about 2.35 percentage points. The volume growth is identical in both calculations, so it does not explain the margin change. The gap between price inflation and input cost inflation does.
Common Exam Traps
Treating sales growth as pure price or pure volume
Exam stems often give both a volume figure and a price or inflation figure. Combine them multiplicatively. Picking only one figure understates or overstates the forecast.
Assuming inflation always helps revenue and ignoring costs
Inflation raises nominal revenue, but if cost inflation moves faster, margins fall even as sales grow. Revenue growth alone does not tell you whether the forecast is good news.
Confusing pricing power's source with its effect
This page covers how pricing power changes a sales and cost forecast. Why a company has pricing power is a Porter's Five Forces question, covered on a separate study note. Do not rebuild that analysis here.
Applying one inflation rate to all costs
Fixed costs do not scale with volume or price level the same way variable costs do. Test questions may isolate fixed costs to check whether you separate them correctly.
Reversing the deflation effect
Some candidates assume deflation only hurts revenue. Deflation can lower both prices and costs. The margin outcome depends on which one falls faster, not on the direction of the price change by itself.
Practice Question
A beverage company forecasts unit volume growth of 4% next year. Selling price inflation is expected to be 3%. The company's key input, aluminum, is expected to rise in cost by 7%. Assume the full variable cost base rises by that rate per unit, with unchanged input mix and no fixed COGS. The company has limited pricing power and can raise prices only in line with the 3% inflation figure. Cost of goods sold equals 55% of revenue in the base year.
Which of the following best describes the most likely effect on the company's gross margin next year?
Gross margin will increase because nominal sales growth exceeds input cost inflation.
Gross margin will decrease because input cost inflation exceeds the increase in selling prices.
Gross margin will stay the same because volume growth offsets the difference between price and cost inflation.
Correct Answer: B
Since COGS grows faster (11.28%) than sales (7.12%), gross margin falls next year. The volume growth rate of 4% applies equally to both sales and COGS, so it does not change the relative gap between price inflation (3%) and input cost inflation (7%). That gap is what drives the margin decline.
Option A: Compares sales growth only to the raw input cost rate of 7%, ignoring that volume growth compounds into COGS growth as well. This understates how fast COGS actually rises.
Option C: Assumes volume growth cancels out the price versus cost inflation gap. Volume growth is common to both sales and COGS, so it does not close that gap. It only scales both figures by the same factor.
Continue Your CFA Level I Prep With KeyPoint
Use structured lessons, practice questions, mock exams, and progress tracking to focus on the time you have left
FAQs About Forecasting Sales and Costs Under Inflation or Deflation
Does CFA Level I require me to calculate exact inflation-adjusted forecasts?
No. The LOS asks you to explain the forecasting approach, not perform heavy calculation. Understand the logic of combining price and volume effects and how that affects margins.
What is the difference between this note and Porter's Five Forces and Forecasting Prices and Costs?
Porter's Five Forces explains why a company has pricing power in the first place. This note explains how to use a pricing power assumption when forecasting sales and costs under inflation or deflation.
Do higher input costs always lower margins?
Not always. If a company can raise prices faster than its costs rise, margins can hold steady or even expand. The margin outcome depends on the relative speed of price changes versus cost changes.
How does deflation differ from disinflation in forecasting?
Deflation means prices are actually falling. Disinflation means inflation is slowing but still positive. This page focuses on the inflation and deflation decision, not on disinflation specifically.
Should sales and cost inflation assumptions always match?
Not necessarily. Input cost inflation and output price inflation often move at different rates. That mismatch is exactly what drives margin changes in a forecast model.