A sector or subsystem approach to the formulation of system dynamics models is described. The approach concentrates on the development of the T’orrester flow or schematic diagram, and incorporates the concept of an interaction matrix to assist in the formulation of such models. The interaction matrix, together with an explicit sequence of steps for model formulation, are described in the paper. This description is followed by applications to illustrative problems. The approach facilitates the determination of the quantities to be included as well as the existence of couplings between the quantities and the identities of the quantities and couplings. A discussion of the limitations, extensions, and possible alternatives to the sector approach concludes the paper, The paper is accompanied by an Appendix which formally derives the interaction matrix. Set and graph thcsorctic concepts are utilized in the derivation. The rules of system dynamics are expressed in the form of definitions, axioms, and an assumption. From these primitives, theorems are proven. The theorems describe whether interaction between certain pairs of quantity types is possible and what type of interaction can exist between the pairs. The theorems are used to rationalize the interaction matrix.