Updated for the 2026-2027 CFA® Level I curriculum.
Forecasting operating expenses and working capital turns a revenue forecast into a usable set of financial statement projections. Analysts need consistent assumptions about costs and short-term assets and liabilities to build a credible forecast.
This note covers the main approaches CFA Level I candidates need for projecting operating expenses and working capital, and how these projections stay linked to revenue and operating assumptions.
Quick Answer
Analysts forecast operating expenses using percent-of-sales ratios, cost behavior analysis (fixed versus variable), or line-by-line detail for major expense categories. Working capital is forecast using turnover ratios or days-based measures (days sales outstanding, days inventory, days payable) tied to the revenue forecast.
Both approaches require assumptions that stay consistent with each other and with the revenue growth assumption driving the entire forecast.
Key Takeaways About Forecasting Operating Expenses and Working Capital
Operating expenses can be forecast as a percentage of sales, by separating fixed and variable costs, or through detailed line-item analysis.
Cost behavior (fixed versus variable) determines how expenses respond to changes in the revenue forecast.
Working capital forecasts typically use efficiency ratios such as days sales outstanding, days inventory on hand, and days payable outstanding.
Working capital assumptions must stay consistent with the revenue growth rate and operating assumptions used elsewhere in the forecast.
Changing one assumption (for example, revenue growth) requires reviewing related working capital and expense assumptions for consistency.
A forecast is only as reliable as the assumptions behind it. It is not a guaranteed outcome.
What You Need to Know for CFA Level I
Identify the main approaches to forecasting operating expenses (percent of sales, fixed/variable split, line-item detail).
Identify the main approaches to forecasting working capital (turnover ratios, days-based measures).
Explain how cost behavior affects expense forecasts as revenue changes.
Explain how working capital assumptions connect back to the revenue forecast.
Recognize when a forecast assumption change requires updating related line items.
Approaches to Forecasting Operating Expenses
Operating expenses include costs like cost of goods sold, selling, general and administrative expenses (SG&A), and research and development. Analysts use three common approaches to project these costs.
Percent-of-sales method
This approach assumes an expense stays at a stable ratio to revenue. If SG&A has been 15% of sales for the past three years, the analyst projects SG&A at 15% of forecast sales. This method is simple and works well when a company's cost structure is stable.
Fixed and variable cost separation
Some expenses do not move proportionally with sales. Rent, for example, is largely fixed in the short term. Sales commissions are variable. Splitting costs this way produces a more accurate forecast when a company has high operating leverage or is scaling production.
Line-item detail method
For major expense categories, analysts sometimes forecast each line separately using specific drivers. Cost of goods sold might be projected using unit volume and per-unit cost. Labor expense might be projected using headcount and average wage. This method takes more effort but produces a more precise forecast when expense categories behave differently from one another.
The choice of method depends on data availability and how much the company's cost structure has changed historically. A company with stable margins is a good candidate for the percent-of-sales method. A company undergoing operating leverage shifts needs the fixed/variable approach.
Approaches to Forecasting Working Capital
Working capital forecasting projects the short-term assets and liabilities tied to daily operations: accounts receivable, inventory, and accounts payable.
Turnover-ratio method
This approach uses historical turnover ratios (receivables turnover, inventory turnover, payables turnover) to project the corresponding balance sheet accounts based on forecast sales or cost of goods sold.
Days-based method
This is the more common Level I approach. It converts turnover into a days measure:
Once an analyst has a historical DSO, DOH, or DPO, that ratio (or an adjusted version of it) is applied to the forecast period's revenue or cost of goods sold to project the account balance.
Working Capital Item | Driver Used | Typical Formula |
|---|---|---|
Accounts receivable | Forecast revenue | |
Inventory | Forecast cost of goods sold | |
Accounts payable | Forecast cost of goods sold |
Notation: DSO, DOH, and DPO are measured in days. Revenue and COGS are the forecast period figures, not historical figures.
How Cost Behavior and Operating Assumptions Affect the Forecast
Cost behavior is the link between the revenue forecast and the expense forecast. A company with mostly variable costs will see expenses grow roughly in line with revenue, keeping margins stable. A company with high fixed costs will see margins expand when revenue grows and contract when revenue falls, because fixed costs do not scale with sales.
How Cost Structure Affects Margins
This matters for Level I because exam scenarios often test whether a candidate can identify how a change in one operating assumption ripples through the forecast. If an analyst raises the revenue growth assumption but the company has high fixed costs, operating margin should improve in the forecast, not stay flat. If the analyst forecasts margin as constant instead, the forecast is internally inconsistent.
Operating assumptions also include planned changes such as cost-cutting initiatives, new capacity additions, or shifts in product mix. Each change should be reflected in the specific expense line it affects rather than applied as a blanket adjustment to all expenses.
How Working-Capital Assumptions Connect to Revenue and Operations
Working capital assumptions cannot be forecast in isolation. Accounts receivable is driven by revenue, so a faster revenue growth assumption pushes up the accounts receivable forecast even if DSO stays flat. Inventory and accounts payable are driven by cost of goods sold, which itself depends on the revenue and margin assumptions already made.
How Working Capital Changes Affect Cash Flow
A change in the revenue forecast therefore has a direct, mechanical effect on the working capital forecast, even without changing any working capital ratio. Analysts must also consider whether operational changes, such as a new inventory management system or a change in supplier payment terms, justify changing DSO, DOH, or DPO independently of the revenue forecast.
The net effect on cash flow depends on the direction of these working capital changes. Rising DSO or DOH uses cash. Rising DPO frees up cash. A consistent forecast reflects the same underlying business assumptions across revenue, expenses, and working capital.
Worked Example
Northfield Supply Co. reported the following for the most recent fiscal year:
Revenue: $80 million
Cost of goods sold: $52 million
DSO: 40 days
DOH: 60 days
DPO: 45 days
An analyst forecasts next year's revenue growth at 10%, with DSO, DOH, and DPO assumptions unchanged.
Step 1: Forecast revenue and COGS
Step 2: Forecast working capital accounts
Because DSO, DOH, and DPO stayed constant, all three working capital accounts grew at roughly the same rate as revenue and COGS. If the analyst instead assumed DOH would fall to 50 days due to a new inventory system, the inventory forecast would drop to about $7.84 million, freeing up cash even though revenue grew.
This shows why working capital assumptions need to be evaluated separately from the revenue growth rate, not simply scaled along with it.
Common Exam Traps
Changing one assumption without updating related line items
Raising the revenue growth rate but leaving expense ratios or working capital days unchanged from a slower-growth scenario creates an inconsistent forecast.
Treating a forecast as certain
A forecast is a set of assumptions, not a guaranteed result. Exam questions may ask candidates to identify the assumption behind a projected number, not to treat the number as fact.
Using inconsistent growth, margin, or financing assumptions
If margin is assumed to expand due to operating leverage, the underlying fixed-cost assumption must support that. Margin and cost structure assumptions need to match.
Confusing a single sensitivity change with a full scenario
A question may ask what happens if only DSO changes, holding everything else constant. This is different from asking what happens across a full revised business scenario, where multiple assumptions move together. Candidates should read the question carefully to see which is being tested.
Practice Question
A company forecasts revenue growth of 8% next year. Historical cost of goods sold has been 60% of revenue, and days inventory on hand (DOH) has been 50 days. The analyst assumes COGS as a percentage of revenue and DOH both stay constant. Current-year revenue is $200 million.
What is the forecast inventory balance for next year?
$16.44 million
$17.75 million
$27.00 million
Correct Answer: B
Inventory is driven by forecast cost of goods sold, not revenue directly. The analyst first grows revenue by 8%, applies the constant COGS margin to get forecast COGS, then applies the DOH ratio to forecast COGS to get the inventory balance.
Calculation steps:
Option A: This answer results from applying DOH to forecast revenue instead of forecast COGS, a common error when candidates forget which driver applies to each working capital account.
Option C: This answer results from applying the 60% COGS margin directly to the DOH days figure or a similar calculation error rather than following the two-step calculation.
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FAQs About Forecasting Operating Expenses and Working Capital
What is the difference between forecasting operating expenses and forecasting working capital?
Operating expenses forecast costs on the income statement, such as SG&A and cost of goods sold. Working capital forecasting projects short-term balance sheet accounts like receivables, inventory, and payables. Working capital forecasts typically depend on the revenue and expense forecasts already completed.
Why do analysts use days-based measures instead of dollar amounts for working capital?
Days-based measures like DSO and DOH adjust automatically for changes in revenue or cost of goods sold. This makes them more useful for forecasting than a flat dollar assumption, since they scale with business activity.
Does higher revenue growth always increase the working capital forecast?
Usually yes, because accounts receivable and inventory typically grow with revenue and cost of goods sold. However, if DSO, DOH, or DPO assumptions change at the same time, the net effect on working capital could be smaller or larger than the revenue growth rate alone would suggest.