Understanding model drivers.

Some models forecast line items in huge amounts of detail. Revenues might be forecast separately for each business segment. Operating costs might be split into COGS, SG&A, and DNA and working capital may be forecast separately for each component of working capital. However, it's important to understand that the forecast cash flows are underpinned by the same drivers, regardless of the model's complexity. These drivers are firstly revenue growth. If revenue growth is higher, forecast profits are higher and therefore also forecast operating cash flows are higher. If profit margins are higher then forecast profits are higher and therefore also forecast operating cash flows are higher. Thirdly, working capital efficiency and Capex spend. Together, these reflect the capital efficiency of the business as they help us to forecast the operating assets needed to generate business revenues. If working capital efficiency is higher, this means the company needs less operating working capital for its operations, which increases forecast operating cash flows. Equally, if the company increases its efficiency around the use of property, plant, and equipment then Capex spend will be lower and this will reduce investing cash outflows. So increases total cash flows generated by the business. So revenue growth, margins, and capital efficiency drive the operating and investing cash flows in our forecasts. But what about the dividend payout assumption in our model. We haven't mentioned this yet but we know it affects cash flows. Well, the dividend payout ratio does impact our cash flows but only our financing cash flows. They don't impact on earnings or operating cash flows. So, we can view dividends as being a financing assumption in our model. To reinforce the importance of these drivers, take a moment to review the Hershey model that we've built and flex the assumptions for revenue growth, operating costs, working capital and Capex, and finally, dividend payout and see how flexing these assumptions impacts on your forecast operating, investing, and financing cash flows.