Link working-capital ratios to operating decisions
Trace a change in the cash cycle to inventory, customer credit and supplier payment decisions.
Section 3.5 · Analysis and communication of accounting information
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. Use the ratio formulae in the syllabus appendix exactly; Cambridge states these are the only formulae accepted. Use year-end balances where appropriate unless the question specifies averages, and round to the requested number of decimal places. Practice is self-checked, not an official Cambridge grade. Full timed Papers 1–4 and human subject-teacher review remain outstanding.
Before you begin
- Use the AS Topic 1.6 ratio, financial-statement and stakeholder skills. These lessons add only the A Level ratios and interpretation required by Topic 3.5.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Which evidence can help explain a rise in receivables days?
What you will learn
- Connect the working capital cycle to its three components
- Explain trade-offs in recommendations
- Avoid judging one ratio without related evidence
Find which component drives the cycle
The cycle combines receivables days + inventory days − payables days. A movement can therefore reflect customer collection, stock holding, supplier payment or a mix. Calculate components individually to identify the source.
Use supporting data such as ageing, stock-outs, write-offs, supplier terms and credit sales. A single total conceals whether cash is tied up in slow customer payment or inventory that protects availability.
Recommend proportionate operating changes
Faster collection may improve cash but stricter credit could reduce sales. Lower inventory can release cash but harm supply or service. Extending supplier days may help short-term cash but can lose discounts or damage terms.
State an action, explain the expected ratio effect, name the operational risk and propose evidence to monitor. Consider customer, supplier and employee consequences as relevant.
Pause and explain
What is a balanced response to high inventory days?
Worked example
A business reduces inventory days by 8, increases receivables days by 5 and keeps payables days unchanged. What happens to the working capital cycle?
Show the worked solution
- Inventory days reduce the cycle by 8 days.
- Receivables days add 5 days to the cycle.
- Net change = −8 + 5 = −3 days.
Answer The working capital cycle becomes 3 days shorter, subject to the underlying figures and timing.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Receivables days rise by 6 and inventory days fall by 10, while payables days are unchanged. Calculate the net cycle movement.
Give me a hint
Apply plus to receivables and plus to inventory movement as stated; the inventory value itself fell.
Compare my reasoning
- Receivables days add 6 days to the cycle.
- Inventory days subtract 10 days from the cycle.
- Net cycle movement = +6 − 10 = −4 days.
The cycle becomes 4 days shorter.
Look for these in your work
- Apply the receivables increase as +6.
- Apply the inventory decrease as −10.
- Calculate the net change as −4 days.
A wholesaler cuts receivables days from 50 to 38 but bad debts double and sales fall 8%. Give a balanced interpretation and one next step.
Give me a hint
The days improved, but examine cost and sales effects before calling the change successful.
Compare my reasoning
- Receivables days improve by 12, which may release cash sooner.
- Higher bad debts and lower sales suggest the new credit policy may be too strict or may have selected poor-risk customers.
- Review customer-level collection, margins and bad-debt causes; adjust credit limits or follow-up without assuming the lower ratio is wholly positive.
Collection time improved, but higher bad debts and lower sales offset the benefit. Review credit quality and margin before revising policy.
Look for these in your work
- Quantify the 12-day improvement.
- Include bad debts and sales decline.
- Propose evidence-based credit-policy review.
A supplier threatens to end a discount for early payment. The accountant proposes delaying settlement to reduce the working capital cycle. What should management compare?
Give me a hint
The cycle formula captures days, but the discount, supplier terms and financing costs affect the decision too.
Compare my reasoning
- Calculate the cash benefit from extra payable days and compare it with the lost discount.
- Consider supplier reliability, future credit terms and any late-payment penalties.
- Compare alternatives such as faster receivables collection or stock planning and recommend the lowest-risk net benefit.
Do not extend payment automatically. Compare the financing benefit with discounts, penalties and supplier risk, alongside other ways to release cash.
Look for these in your work
- Compare extra payable days with the lost discount.
- Assess supplier and penalty consequences.
- Consider alternative working-capital actions.
Common mistakes
- Recommending universal minimum stock
- Assuming late payment to suppliers is sustainable
- Ignoring changes in sales mix or credit policy
What can you explain now?
If receivables days rise by 4 and other components stay fixed, what happens to the cycle?
Compare with the explanation
It rises by 4 days
Receivables days are added in the working capital cycle formula.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Name one potential benefit and one trade-off for each of receivables, inventory and payables actions.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.