The way it was explained to me on another forum, copied and pasted in full with emphasis added to a relevant bit:
Your child will be offered a place at your highest-ranked school for which places are available.
The system essentially sorts all the applications into a priorty order for each school according to the school's admission policy (all of which have to be published and which CANNOT include things like "need to be first choice on the CAF"). Then it fills places according to the order in which the parents' ranked them.
Let's say you're one of 500 people who apply for Schools A, B and C, with everyone ranking them in that order. School A is long way away from where you live you're outside catchment and loads of other children live closer to it, so you're in 400th place on their list. You're still outside catchment for School B but it's much closer than School A, so you're in 125th on their list. School C is at the end of your road, so you're 10th on their list - but it's in special measures, regularly has the fire brigade outside and recently had to start screwing down chairs to stop kids throwing them. You'd rather not send your kids there.
Each school has 150 places, so the admissions authority works its way down the list of applicants in rank order and offers places according to the priority given by parents. School A is wildly oversubscribed, so is quickly able fill all 150 places with people who put it as their first choice. With not enough places for everyone who put it as their first choice there's not even any need to look at who put it as their second choice - this is what some heads mean when they say "if you want a place here you must put us as your first choice".
There is room for your child at Schools B and C, so you are offered a place according to your rank order, which in this case School B even though School C is much closer.
Thinking of trying to game the system by only putting down School A? Big mistake. If you cannot be offered a place at the one school you select, you will be allocated a place the closest school which has places available. In this case it would be School C, but it could easily end up being School D, which is somehow even worse and requires a two-hour bus trip each way.
The single most important thing to remember when filling out the CAF form - the ONLY important thing to remember! - is to simply rank the schools in your preferred order. Even if it is exceptionally unlikely that you will get a place at your first choice, you should still put it as your first choice. The system doesn't know your inner thoughts or motivations, it will simply do its best to place your child in the highest-ranked school it can manage. And if you don't want your child to go to a specific school, don't put it on your form - just make sure you have a realistic chance of getting a place at one of the schools you DO choose, otherwise the choice will be taken out of your hands.