Skip to content

CFA Level I Exam · Introduction to Financial Statement Modeling

Forecasting Costs, Working Capital and Capex

Updated 7 October 2026 · Fact-checked

Forecasting costs, working capital and capex means projecting expense lines, balance sheet items and investment spending from drivers. Tie COGS to revenue through gross margin, use days ratios for receivables, inventory and payables, link capex to sales or capacity, and compute depreciation from the asset base. Then check the statements still balance.

Understand Forecasting Costs, Working Capital and Capex

A financial statement model starts with a revenue forecast. Everything else is built from it. Costs, working capital and capex are the next layer, and each is driven by a ratio or an operating assumption.

Costs. COGS usually moves with revenue, so you forecast it as a percentage of sales or through a gross margin. SG&A has a fixed part (rent, salaries) and a variable part (commissions, marketing). If you treat it all as variable, you miss operating leverage: when sales rise, fixed costs spread over more revenue and the operating margin expands. Analysts often forecast SG&A as a percentage of sales, or as last year's amount grown by inflation plus a step for expansion.

Working capital. Receivables, inventory and payables grow with the business. Use turnover or days ratios from history. Days sales outstanding (DSO) drives receivables from sales. Days inventory on hand (DIH) drives inventory from COGS. Days payables outstanding (DPO) drives payables from COGS. Cash tied up is the change in net working capital, which reduces operating cash flow when it rises.

Capex and depreciation. Capex can be forecast as a percentage of sales, as a multiple of depreciation, or from management plans and capacity needs. Growth firms spend more than depreciation; mature firms spend close to it. Net PP&E rolls forward as beginning PP&E plus capex minus depreciation. Depreciation is then based on the asset base, not simply on sales.

Financing costs. Interest expense comes from debt balances and the interest rate. Using average debt is more accurate but creates circularity, because interest affects cash, which affects debt. Using beginning debt avoids the circularity. Always sanity-check results against history and peers, and keep the balance sheet balanced.

Key formulas to remember

COGS from gross margin
COGS = Revenue × (1 − gross margin)
Equivalent to forecasting COGS as a percentage of revenue.
Days sales outstanding
Receivables = DSO × Revenue ÷ 365
Use the same day-count (365 or 360) as the source data.
Days inventory on hand
Inventory = DIH × COGS ÷ 365
Inventory is based on COGS, not revenue.
Days payables outstanding
Payables = DPO × COGS ÷ 365
Also based on COGS (purchases if given).
Net working capital change
ΔNWC = change in (receivables + inventory) − change in payables
An increase is a cash outflow.
PP&E roll-forward
Ending net PP&E = Beginning net PP&E + Capex − Depreciation
Ignores disposals and impairments unless given.
Straight-line depreciation
Depreciation = (Cost − Salvage value) ÷ Useful life
Apply to the gross depreciable base.
Interest expense
Interest = Interest rate × Debt balance
Beginning balance avoids circularity; average balance is more precise.
Operating margin effect
Operating income = Revenue − COGS − SG&A − Depreciation
Fixed costs create operating leverage.

How to solve Forecasting Costs, Working Capital and Capex questions

Use this order for any question on forecasting costs, working capital or capex.

  1. 1Identify the driver the question gives: margin, percent of sales, days ratio, or capex rule.
  2. 2Find the base that matches the driver: revenue for DSO, COGS for inventory and payables.
  3. 3Compute each forecast line separately, keeping the day-count consistent.
  4. 4For working capital, compute the balance for each year, then take the change between years.
  5. 5For capex, roll forward PP&E: beginning plus capex minus depreciation.
  6. 6Compute interest from the stated debt balance and rate, using the balance the question specifies.
  7. 7Assemble the effect (operating income, cash flow, or balance) and check signs: a rise in NWC reduces cash.
  8. 8Eliminate options that use the wrong base or the wrong sign.

Quickest way: Base, ratio, change

When to use it: Use for numerical items where the question gives one or two ratios and asks for a single balance or cash effect.

  1. Write the base (revenue or COGS) for each year.
  2. Multiply by days ÷ 365 to get the balance.
  3. Subtract the prior balance to get the change.
  4. Assign the sign: asset up means cash down; liability up means cash up.
  5. Pick the matching option, using the smallest-to-largest ordering to check magnitude.

Common mistakes in Forecasting Costs, Working Capital and Capex

  • Forecasting inventory and payables from revenue.

    Students apply DSO logic to every working capital item.

    Fix: Receivables use revenue. Inventory and payables use COGS.

  • Reporting the working capital balance instead of the change.

    The question asks for cash flow impact but the student stops after computing the balance.

    Fix: Subtract the prior-year balance and then apply the sign to cash flow.

  • Treating all SG&A as variable.

    Percent-of-sales is the easiest shortcut.

    Fix: Split fixed and variable costs when told; fixed costs create operating leverage and widen margins as sales grow.

  • Depreciating capex in the year spent.

    Confusing cash outlay with expense.

    Fix: Capex goes to PP&E; only depreciation hits the income statement, over the useful life.

  • Ignoring that gross margin and COGS ratio are complements.

    Rushing under time pressure.

    Fix: If gross margin is 40%, COGS is 60% of revenue.

  • Forgetting circularity in interest forecasts.

    Average debt depends on cash flow, which depends on interest.

    Fix: Know that average balances create circularity and beginning balances avoid it.

Worked examples

Example 1

A company forecasts next-year revenue of €500 million with a gross margin of 36%. DIH is 73 days and DPO is 45.625 days on a 365-day year. What is forecast inventory?

Show the solution
  1. COGS = 500 × (1 − 0.36) = 500 × 0.64 = €320 million.
  2. Inventory = 73 × 320 ÷ 365.
  3. 73 ÷ 365 = 0.2, so inventory = 0.2 × 320 = €64 million.

Answer: Forecast inventory is €64 million. The DPO is not needed for this question.

Example 2

Revenue rises from $400 million to $460 million. DSO is 60 days, DIH is 73 days and DPO is 36.5 days. COGS is 70% of revenue. Last year's receivables, inventory and payables were $65.753 million, $57.534 million and $27.397 million. Estimate the cash effect of the change in net working capital for the new year (use 365 days).

Show the solution
  1. New COGS = 0.70 × 460 = $322 million.
  2. Receivables = 60 × 460 ÷ 365 = $75.616 million.
  3. Inventory = 73 × 322 ÷ 365 = 0.2 × 322 = $64.4 million.
  4. Payables = 36.5 × 322 ÷ 365 = 0.1 × 322 = $32.2 million.
  5. New NWC = 75.616 + 64.4 − 32.2 = $107.816 million.
  6. Old NWC = 65.753 + 57.534 − 27.397 = $95.890 million.
  7. Change = 107.816 − 95.890 = $11.926 million increase.

Answer: Net working capital rises by about $11.9 million, so operating cash flow falls by about $11.9 million.

Exam tips

  • Check the base first: revenue for receivables, COGS for inventory and payables.
  • An increase in net working capital is a cash outflow. Many wrong options differ only in sign.
  • Read whether the question uses a 365 or 360-day year and match it.
  • For capex questions, use the roll-forward and watch whether depreciation is given or must be computed.
  • If options differ by about the same gap as one year's change, you probably reported a balance instead of the change.

Practice questions from Introduction to Financial Statement Modeling

Forecasting Costs, Working Capital and Capex: frequently asked questions

How do you forecast COGS in a financial model?

Start with the revenue forecast and apply a COGS percentage or one minus the gross margin. Adjust the ratio if input costs, pricing or mix are expected to change. Check the result against history and peers.

Why are inventory and payables forecast from COGS?

Both relate to the cost of goods the firm buys and sells, not to the selling price. Using COGS keeps the days ratio consistent with how the ratio is calculated from historical data.

How is capex forecast?

Common approaches are a percentage of sales, a multiple of depreciation, or management guidance tied to capacity plans. Growing firms usually spend more than depreciation. Then roll forward PP&E and compute depreciation from the asset base.

Why does interest expense create circularity?

If you use average debt, interest affects net income and cash flow, which changes the debt balance, which changes interest. Using the beginning debt balance breaks the loop.