Forecasting free cash flow

A forecast should be driven by assumptions, not typed in. A common structure: grow revenue, express margins and reinvestment as percentages of revenue, and keep every assumption in one clearly labelled block. Change one input and the whole forecast updates.

Working capital is usually forecast as a level (a % of revenue). The cash-flow effect is its change from the previous year — so a growing business keeps investing in working capital even at a constant percentage.

Why percentages of revenue? Most operating lines scale with activity: more sales need more stock, more receivables and eventually more capacity. Tying each line to revenue keeps the forecast internally consistent — you cannot accidentally grow sales 20% a year while capex stays flat — and it lets a reviewer see the few judgements that matter: growth, margin and reinvestment intensity.

A step-by-step build, one column per year:

1. Revenue = last year's revenue × (1 + growth).
2. EBIT = revenue × EBIT margin; NOPAT = EBIT × (1 − tax rate).
3. D&A and capex = revenue × their percentages.
4. NWC level = revenue × NWC%; ΔNWC = this year's level − last year's.
5. FCF = NOPAT + D&A − capex − ΔNWC.

Use absolute references ($B$3) for the assumptions so one formula can be copied across the years. Where do the percentages come from? Usually from the company's recent history (the financial-statement analysis track), adjusted for management plans and what peers achieve, and then challenged: does the margin path make sense against the competition, and is capex enough to support the growth?