Explain working capital and the difference between cash and profit
Use statements and ratios to recommend improvements to profitability, liquidity and working capital while keeping cash separate from profit.
Cambridge IGCSE Accounting 0452 / (9–1) 0985, 2027–2029 Version 1. These lessons follow the 2027–2029 syllabus only; the separate 2026 syllabus update is not yet mapped. Written practice is self-checked, not an official Cambridge grade. Full timed-paper practice and human subject-teacher review remain pending.
Before you begin
- No previous accounting study is assumed. Keep the business, transaction and accounting period in view, and distinguish a resource, a claim and a performance result.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
A credit sale is recorded, but the customer has not paid. What may happen?
What you will learn
- Suggest actions to improve profitability, liquidity and working capital
- Explain why cash and profit differ
- Connect inventory valuation and other income or expenses to profit
Link recommendations to the diagnosed problem
Profitability actions may include reviewing prices, supplier costs, product mix or overheads. Liquidity and working-capital actions may include collecting receivables earlier, planning inventory levels or negotiating supplier terms, subject to customer and supplier effects.
Use the evidence to choose an action. Cutting a cost can harm service or quality; delaying payment can damage supplier relationships. State the intended benefit and one relevant risk.
Profit is not cash generated
Credit sales can increase income before cash is collected; buying inventory can use cash before the goods are sold; accruals, prepayments and depreciation also affect profit and cash in different ways.
Gross profit can change with inventory valuation, sales quantity, and selling or purchasing prices. Profit for the year also changes with other income and expenses. Separate these causes when analysing performance.
Pause and explain
A shop has slow-moving inventory and a long receivables period. Which working-capital focus is most relevant?
Worked example
A business earns profit $20,000 but receives only $12,000 cash from customers during the period. It also pays $9,000 for inventory that remains unsold and records depreciation $3,000. Explain why cash and profit differ without assuming an error.
Show the worked solution
- Some credit sales may be included in income before customers pay, so profit can exceed cash received.
- Cash paid for unsold inventory creates or increases an asset rather than all becoming current-period cost of sales.
- Depreciation reduces profit without a current cash payment; the figures describe different measures and timing.
Answer Cash and profit differ because of credit transactions, inventory timing and non-cash depreciation. The difference is not automatically an error; reconcile the relevant balances and evidence.
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.
A business has profit $15,000, depreciation $2,000, credit sales $30,000 of which $8,000 remains unpaid, and inventory purchases $12,000 of which $3,000 remains unsold. Explain at least three reasons cash movement will not equal profit.
Give me a hint
Separate non-cash expenses, unpaid income and stock still held from current cash transactions.
Compare my reasoning
- Depreciation reduces profit by $2,000 without itself using cash this period.
- The $8,000 unpaid sales may be income and receivables before cash collection.
- The $3,000 unsold inventory remains an asset, not all current-period cost of sales.
Profit and cash differ because depreciation is non-cash, credit income may be unpaid, and unsold inventory remains an asset. Other opening balances and payments also matter.
Look for these in your work
- Non-cash item explained
- Credit timing explained
- Inventory timing explained
A firm has a falling gross-profit margin and rising supplier prices. Suggest one action, the financial effect sought and one risk to investigate.
Give me a hint
Tie the action to the price/cost evidence and consider a customer or supplier consequence.
Compare my reasoning
- Review selling prices, product mix or purchasing terms using cost and demand data.
- The aim may be to protect gross profit or margin by improving revenue per unit or reducing cost.
- Check customer response, competitor prices, product quality and supplier reliability before changing policy.
Review pricing, mix or supplier terms to protect margin, but check demand, competition, quality and supplier reliability before acting.
Look for these in your work
- Action relevant
- Financial objective stated
- Risk considered
A business wants to reduce receivables days from 70 to 50. Suggest two controls and one potential drawback of stricter credit.
Give me a hint
Consider how invoices are issued, followed up and approved for credit.
Compare my reasoning
- Issue accurate invoices promptly and review aged receivables with scheduled reminders.
- Set and consistently assess credit limits and overdue-account procedures.
- Stricter credit may reduce bad debts but could lose sales or harm relationships with reliable customers.
Prompt invoices, aged-debt follow-up and suitable credit limits may improve collection. Stricter credit can also deter good customers, so assess sales and risk together.
Look for these in your work
- Two controls practical
- Collection effect explained
- Customer drawback included
Common mistakes
- Treating every cash receipt as profit
- Calling inventory purchases an expense before considering stock unsold
- Recommending late supplier payment without weighing terms
- Assuming depreciation is a cash payment
What can you explain now?
Can depreciation reduce profit without reducing cash in the same period?
Compare with the explanation
Yes; it is a non-cash allocation
The depreciation expense does not itself record a cash payment.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Give two reasons cash received in a period can differ from profit for that period.
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.