Why is "Using revenue instead of cost of sales for inventory turnover" a common mistake in Liquidity and Working Capital Management Ratios?

Why it happens: Defaulting to sales. How to avoid it: Inventory turnover uses COST OF SALES ÷ average inventory, not revenue. Source: 9706 Examiner Reports

Why is "Using total sales/purchases instead of credit figures" a common mistake in Liquidity and Working Capital Management Ratios?

Why it happens: Ignoring the split. How to avoid it: Use CREDIT sales for receivables days and CREDIT purchases for payables days where the split is given. Source: 9706 Examiner Reports

Why is "Including inventory in the acid-test ratio" a common mistake in Liquidity and Working Capital Management Ratios?

Why it happens: Treating it like the current ratio. How to avoid it: The acid-test EXCLUDES inventory (the least liquid current asset). Source: 9706 Examiner Reports

Why is "Giving the number with no interpretation" a common mistake in Liquidity and Working Capital Management Ratios?

Why it happens: Stopping at the calculation. How to avoid it: Explain what the ratio/change MEANS and what could be done — number → meaning → action. Source: 9706 Examiner Reports

Why is "Assuming a higher ratio is always better" a common mistake in Liquidity and Working Capital Management Ratios?

Why it happens: Equating high with safe. How to avoid it: Too high a current ratio can mean idle resources; balance liquidity against efficiency. Source: 9706 Examiner Reports

Cambridge International A Levels Accounting (9706)

Liquidity and Working Capital Management Ratios

Q: Why is "Adding payables days in the cash cycle" a common mistake in Liquidity and Working Capital Management Ratios?

Why it happens: Forgetting it is subtracted. How to avoid it: Cash cycle = inventory days + receivables days − PAYABLES days (payables are subtracted). Source: 9706 Examiner Reports

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Detailed Study Notes

Detailed notes on Analysis and Communication of Accounting Information for Cambridge International A Levels Accounting, covering key concepts, explanations, examples, and exam-focused revision points.

Liquidity & Working Capital Management Ratios — Cambridge AS & A Level Accounting 9706 Study Notes (2026-2028)

Measuring short-term financial health. Master the current ratio and acid-test (quick) ratio, the efficiency ratios for inventory, trade receivables and trade payables, and how they combine into the working capital (cash operating) cycle.

At a glance

Liquidity = the ability to pay short-term debts as they fall due.
Current ratio = current assets ÷ current liabilities (often expressed X : 1).
Acid-test (quick) ratio = (current assets − inventory) ÷ current liabilities.
Inventory turnover = cost of sales ÷ average inventory (times) or × 365 for days.
Trade receivables days = (trade receivables ÷ credit sales) × 365.
Trade payables days = (trade payables ÷ credit purchases) × 365.
Working capital (cash) cycle = inventory days + receivables days − payables days.

What you’ll learn

Mapped to the Cambridge International A Level 9706 syllabus (2026-2028).

3.8 — Calculate and interpret liquidity ratios (current and acid-test).
3.8 — Calculate and interpret working-capital efficiency ratios (inventory, receivables, payables).
3.8 — Calculate the working capital (cash operating) cycle.

The liquidity ratios

Current and acid-test ratios measure the ability to pay short-term debts.

Liquidity is the ability to meet short-term obligations (current liabilities) as they fall due. Two ratios measure it:

Current ratio:

$\text{Current ratio} = \frac{\text{Current assets}}{\text{Current liabilities}}$

Expressed as X : 1. A ratio around 1.5–2 : 1 is often considered comfortable, though it varies by industry. Too low suggests difficulty paying debts; too high may mean idle resources (excess cash/inventory).

Acid-test (quick) ratio:

$\text{Acid-test ratio} = \frac{\text{Current assets} - \text{Inventory}}{\text{Current liabilities}}$

This excludes inventory (the least liquid current asset, as it must first be sold and then collected). A ratio around 1 : 1 is often seen as adequate. It is a stricter test of whether the business could pay its debts without relying on selling inventory.

Liquidity = ability to pay short-term debts.
Current ratio = current assets ÷ current liabilities (X : 1).
Acid-test = (current assets − inventory) ÷ current liabilities.
Acid-test excludes inventory (the least liquid current asset).

See the full worked example for liquidity and working capital management ratios →

Working-capital efficiency ratios

Inventory, receivables and payables turnover/days.

These ratios measure how efficiently the business manages the elements of working capital:

Inventory turnover:

$\text{Inventory turnover (times)} = \frac{\text{Cost of sales}}{\text{Average inventory}} \qquad \text{or} \qquad \text{Inventory days} = \frac{\text{Average inventory}}{\text{Cost of sales}} \times 365$

(Average inventory = (opening + closing) ÷ 2.) Faster turnover (more times / fewer days) usually means efficient stock management.

Trade receivables collection period (days):

$\frac{\text{Trade receivables}}{\text{Credit sales}} \times 365$

Shows how long, on average, customers take to pay. Fewer days = better credit control.

Trade payables payment period (days):

$\frac{\text{Trade payables}}{\text{Credit purchases}} \times 365$

Shows how long the business takes to pay suppliers. More days means using suppliers' credit longer (but too long risks losing goodwill/discounts).

Inventory turnover = cost of sales ÷ average inventory (times), or × 365 for days.
Receivables days = (receivables ÷ credit sales) × 365.
Payables days = (payables ÷ credit purchases) × 365.
Faster inventory/receivables, reasonable payables = good management.

See the full worked example for liquidity and working capital management ratios →

The working capital (cash) cycle

Inventory days + receivables days − payables days.

The working capital cycle (also the cash operating cycle) measures the time between paying for inventory and receiving cash from customers:

$\text{Working capital cycle} = \text{Inventory days} + \text{Trade receivables days} - \text{Trade payables days}$

Example. Inventory 60 days + receivables 45 days − payables 30 days = 75 days.

A shorter cycle is generally better — cash is tied up for less time, improving liquidity. The cycle can be shortened by:

reducing inventory days (faster stock turnover);
reducing receivables days (tighter credit control / quicker collection);
increasing payables days (taking longer to pay suppliers — within reason).

A very long cycle ties up cash and may signal overtrading risk; a negative cycle (some retailers) means the business receives cash before it pays suppliers — very favourable.

Cash cycle = inventory days + receivables days − payables days.
A shorter cycle ties up less cash (better liquidity).
Shorten by faster inventory/collection or longer payment to suppliers.
A long cycle risks overtrading; a negative cycle is very favourable.

See the full worked example for liquidity and working capital management ratios →

Interpreting liquidity sensibly

Compare over time and against norms; balance liquidity and efficiency.

Ratios mean little in isolation — interpret them by comparing over time (trend) and against industry norms or competitors. Key judgements:

A falling current/acid-test ratio may warn of liquidity problems; a rising one may show improvement or idle resources.
High inventory or receivables days tie up cash and may indicate slow-moving stock or poor credit control.
There is a trade-off: too little working capital risks insolvency; too much wastes resources that could earn returns.

Working capital management aims to hold just enough inventory, collect receivables promptly, and use supplier credit sensibly, keeping the cash cycle short without harming trading relationships. So liquidity ratios are read alongside profitability and the business's circumstances — a strong answer always explains what a change means and what could be done, not just the number.

Compare ratios over time and against norms/competitors.
Falling liquidity ratios warn of problems; too high may be idle resources.
Trade-off: too little working capital risks insolvency; too much wastes resources.
Good management = enough inventory, prompt collection, sensible supplier credit.

Quick recap

Current ratio = current assets ÷ current liabilities; acid-test excludes inventory.
Inventory turnover = cost of sales ÷ average inventory (times) or × 365 for days.
Receivables days = (receivables ÷ credit sales) × 365; payables days similarly on purchases.
Working capital cycle = inventory days + receivables days − payables days.
A shorter cycle ties up less cash; balance liquidity against efficiency.
Interpret by comparing over time/against norms and link to causes and actions.

Memorise this

Verbatim phrases and definitions Cambridge mark schemes credit.

Current ratio = current assets ÷ current liabilities.
Acid-test = (current assets − inventory) ÷ current liabilities.
Inventory turnover = cost of sales ÷ average inventory; days = × 365.
Receivables days = (receivables ÷ credit sales) × 365; payables days = (payables ÷ credit purchases) × 365.
Cash cycle = inventory days + receivables days − payables days.

How it’s examined

Tested on Paper 3 (A Level): calculate liquidity and working-capital ratios, calculate the cash cycle, and interpret/advise on a business's liquidity (commonly [6-12] marks). Examiner reports note candidates using revenue instead of cost of sales for inventory turnover, and giving the number without interpretation.

Sources: Cambridge International AS & A Level Accounting 9706 syllabus (2026-2028); 9706 Paper 3 past papers & mark schemes, 2022-2024; 9706 Examiner Reports, 2022-2024. Last reviewed 2026-06-19.

Take this whole topic with you

Step-by-step worked examples — Liquidity and Working Capital Management Ratios

Step-by-step solutions to past-paper-style questions on liquidity and working capital management ratios, written exactly the way a tutor would explain them at the board.

Question type:

1Current ratio (3 marks)
Getting startedDirect calculation• 9706 Paper 3 style• current ratio, AO2
Question
Current assets $90,000; current liabilities$ 50,000. Calculate the current ratio. (3 marks)
Step-by-step solution
1. Step 1
  Current ratio = current assets ÷ current liabilities.
2. Step 2
  = 90,000 ÷ 50,000.
3. Step 3
  = 1.8 : 1.
Answer
1.8 : 1.
Examiner tip
Express as X : 1.
2Acid-test ratio (4 marks)
Getting startedMulti-step problem• acid-test, AO2
Question
Current assets $90,000 (including inventory$ 36,000); current liabilities $50,000. Calculate the acid-test ratio. (4 marks)
Step-by-step solution
1. Step 1
  Acid-test = (current assets − inventory) ÷ current liabilities.
2. Step 2
  = (90,000 − 36,000) ÷ 50,000 = 54,000 ÷ 50,000.
3. Step 3
  = 1.08 : 1.
Answer
1.08 : 1.
Examiner tip
Exclude inventory from the numerator.
3Inventory turnover (4 marks)
Getting startedMulti-step problem• inventory turnover, AO2
Question
Cost of sales $300,000; opening inventory$ 45,000; closing inventory $55,000. Calculate the inventory turnover in times. (4 marks)
Step-by-step solution
1. Step 1
  Average inventory = (45,000 + 55,000) ÷ 2 = $50,000.
2. Step 2
  Inventory turnover = cost of sales ÷ average inventory = 300,000 ÷ 50,000.
3. Step 3
  = 6 times.
Answer
6 times.
Examiner tip
Use COST OF SALES and average inventory.
4Receivables and payables days (5 marks)
Building confidenceMulti-step problem• days ratios, AO2
Question
Trade receivables $48,000; credit sales$ 400,000. Trade payables $30,000; credit purchases$ 250,000. Calculate the receivables and payables days. (5 marks)
Step-by-step solution
1. Step 1
  Receivables days = (48,000 ÷ 400,000) × 365 = 0.12 × 365 = 43.8 ≈ 44 days.
2. Step 2
  Payables days = (30,000 ÷ 250,000) × 365 = 0.12 × 365 = 43.8 ≈ 44 days.
Answer
Receivables ≈ 44 days; payables ≈ 44 days.
Examiner tip
Use CREDIT sales/purchases where given.
5Inventory days (4 marks)
Building confidenceMulti-step problem• inventory days, AO2
Question
Average inventory $50,000; cost of sales$ 300,000. Calculate the inventory holding period in days. (4 marks)
Step-by-step solution
1. Step 1
  Inventory days = (average inventory ÷ cost of sales) × 365.
2. Step 2
  = (50,000 ÷ 300,000) × 365.
3. Step 3
  = 0.1667 × 365 = 60.8 ≈ 61 days.
Answer
≈ 61 days.
Examiner tip
Inventory days = 365 ÷ inventory turnover (= 365 ÷ 6 ≈ 61).
6Working capital cycle (4 marks)
StretchMulti-step problem• cash cycle, AO2
Question
Inventory days 61; receivables days 44; payables days 44. Calculate the working capital (cash) cycle. (4 marks)
Step-by-step solution
1. Step 1
  Cycle = inventory days + receivables days − payables days.
2. Step 2
  = 61 + 44 − 44.
3. Step 3
  = 61 days.
Answer
61 days.
Examiner tip
Add inventory and receivables days, subtract payables days.
7Interpret a falling current ratio (5 marks)
StretchWord problem• interpretation, AO3
Question
A company's current ratio has fallen from 2.0 : 1 to 1.1 : 1 over two years. Interpret this and suggest one action. (5 marks)
Step-by-step solution
1. Step 1
  The current ratio has fallen sharply — liquidity has weakened.
2. Step 2
  At 1.1 : 1 the business has only just enough current assets to cover current liabilities.
3. Step 3
  It may struggle to pay short-term debts as they fall due → liquidity risk.
4. Step 4
  Possible causes: rising payables/overdraft, falling cash, or building inventory.
5. Step 5
  Action: improve credit control, reduce inventory, or arrange longer-term finance to ease the strain.
Answer
Liquidity has weakened (2.0 → 1.1); risk of not paying short-term debts; improve cash management.
Examiner tip
Link number → meaning (liquidity risk) → action.
8Shortening the cash cycle (4 marks)
StretchWord problem• cash cycle, AO3
Question
Explain three ways a business could shorten its working capital cycle. (4 marks)
Step-by-step solution
1. Step 1
  Reduce inventory days — hold less stock / turn it over faster (e.g. JIT).
2. Step 2
  Reduce receivables days — tighter credit control, prompt-payment discounts, chasing debtors.
3. Step 3
  Increase payables days — take longer to pay suppliers (within agreed terms).
4. Step 4
  Each frees up cash by reducing the time cash is tied up in working capital.
Answer
Cut inventory days, cut receivables days, extend payables days — each frees cash.
Examiner tip
Three levers: inventory, receivables, payables.
9Can liquidity be too high? (4 marks)
StretchWord problem• interpretation, AO3
Question
A company has a current ratio of 4 : 1. Explain why a very high current ratio may not be a good sign. (4 marks)
Step-by-step solution
1. Step 1
  A very high ratio means the business holds a lot of current assets relative to liabilities.
2. Step 2
  This may indicate idle/excess cash, too much inventory, or slow-paying receivables.
3. Step 3
  These resources are not earning a return — money tied up could be invested.
4. Step 4
  So an excessively high ratio can signal poor use of resources, not just safety.
Answer
It may mean idle cash, excess inventory or slow receivables — resources not earning returns.
Examiner tip
Too high can mean inefficiency, not just strong liquidity.
10Spotting overtrading risk (4 marks)
StretchWord problem• interpretation, AO3
Question
A rapidly growing company has a long and lengthening working capital cycle and a falling acid-test ratio. Explain the risk this suggests. (4 marks)
Step-by-step solution
1. Step 1
  Rapid growth with a lengthening cash cycle ties up more and more cash in inventory and receivables.
2. Step 2
  A falling acid-test ratio shows liquidity is weakening.
3. Step 3
  Together these suggest overtrading — expanding faster than the cash can support.
4. Step 4
  The business risks being unable to pay short-term debts despite being profitable.
Answer
Overtrading — growing faster than cash allows, risking inability to pay short-term debts.
Examiner tip
Profitable growth can still cause a liquidity crisis (overtrading).

Model Answers — Liquidity and Working Capital Management Ratios

High-scoring sample answers for liquidity and working capital management ratios on the Cambridge IGCSE paper, with examiner-style notes mapping each response to the mark scheme and assessment objectives.

Question 1
9706 Paper 3 style3 marks
Q (3 marks). Current assets are $120,000 and current liabilities are$ 75,000. Calculate the current ratio.
Model answer
Current ratio = 120,000 ÷ 75,000 = 1.6 : 1.
Why this scores
Marking (point-based, 3). Method (1); 1.6 : 1 (2).
Question 2
9706 Paper 3 style4 marks
Q (4 marks). Current assets $120,000 (inventory$ 48,000); current liabilities $75,000. Calculate the acid-test ratio and comment.
Model answer
Acid-test = (120,000 − 48,000) ÷ 75,000 = 72,000 ÷ 75,000 = 0.96 : 1. At just below 1 : 1, the business has slightly less than $1 of liquid assets per $1 of current liabilities, so it would rely a little on selling inventory to meet its short-term debts.
Why this scores
Marking (point-based, 4). 0.96 : 1 (2); brief comment (2).
Question 3
9706 Paper 3 style4 marks
Q (4 marks). Cost of sales $480,000; opening inventory$ 55,000; closing inventory $65,000. Calculate the inventory turnover (times) and the inventory days.
Model answer
Average inventory = (55,000 + 65,000) ÷ 2 = $60,000. Inventory turnover = 480,000 ÷ 60,000 = 8 times. Inventory days = 365 ÷ 8 = ≈ 46 days.
Why this scores
Marking (point-based, 4). Average $60,000 (1); 8 times (2); ≈46 days (1).
Question 4
9706 Paper 3 style5 marks
Q (5 marks). Credit sales $600,000; trade receivables$ 66,000. Credit purchases $380,000; trade payables$ 50,000. Calculate the trade receivables and trade payables collection/payment periods in days.
Model answer
Receivables days = (66,000 ÷ 600,000) × 365 = 0.11 × 365 = ≈ 40 days. Payables days = (50,000 ÷ 380,000) × 365 = 0.1316 × 365 = ≈ 48 days.
Why this scores
Marking (point-based, 5). Receivables ≈40 days (2.5); payables ≈48 days (2.5). Use credit figures.
Question 5
9706 Paper 3 style5 marks
Q (5 marks). A business has inventory days of 46, receivables days of 40 and payables days of 48. Calculate the working capital cycle and explain what it represents.
Model answer
Working capital cycle = inventory days + receivables days − payables days = 46 + 40 − 48 = 38 days. This represents the average length of time (38 days) between the business paying its suppliers for goods and receiving cash from its customers — i.e. how long cash is tied up in working capital. A shorter cycle is generally better for liquidity.
Why this scores
Marking (point-based, 5). 38 days (3); meaning — time cash tied up (2).
Question 6
9706 Paper 3 style6 marks
Q (6 marks). Over two years, a company's current ratio rose from 1.6 : 1 to 3.2 : 1, its inventory days rose from 45 to 80 and its receivables days rose from 35 to 70. Discuss what this suggests about its working capital management.
Model answer
Although the current ratio has risen (1.6 : 1 to 3.2 : 1), suggesting at first glance stronger liquidity, the detail is concerning. Inventory days have risen sharply (45 → 80), meaning stock is being held much longer — possibly slow-moving or obsolete inventory tying up cash. Receivables days have doubled (35 → 70), indicating weak credit control — customers are taking far longer to pay, again tying up cash and increasing the risk of irrecoverable debts.

So the higher current ratio is driven not by genuine financial strength but by bloated inventory and receivables, which is a sign of poor working capital management and idle resources rather than improvement. The company should reduce inventory (better stock control/JIT), tighten credit control (credit limits, prompt-payment incentives, chasing debtors), and so shorten its working capital cycle to free up cash. A high current ratio is therefore not automatically good — the quality of the current assets matters.
Why this scores
Marking (point-based, 6). Higher current ratio but poor detail (~2); inventory & receivables tying up cash (~2); actions / high ratio not always good (~2).
Question 7
9706 Paper 3 style4 marks
Q (4 marks). Explain two actions a business could take to shorten its working capital cycle.
Model answer
1. Reduce inventory days — hold less inventory and turn it over faster (e.g. better stock control or just-in-time), so cash is not tied up in unsold stock. 2. Reduce receivables days — improve credit control by setting credit limits, sending statements/reminders, and offering discounts for prompt payment, so customers pay sooner. (Extending payables days, within agreed terms, also shortens the cycle.) Each reduces the time cash is tied up in working capital.
Why this scores
Marking (point-based, 4). Two actions with explanation (2 + 2).
Question 8
9706 Paper 3 style4 marks
Q (4 marks). A company has a current ratio of 3.5 : 1 and an acid-test ratio of 2.8 : 1. Explain why these ratios might concern management despite appearing strong.
Model answer
Although both ratios appear very strong, they may indicate that the company is holding excessive current assets — too much cash sitting idle, inventory that is not being sold, or receivables that are not being collected. These resources are not earning a return: idle cash could be invested or used to expand, and excess inventory ties up cash and risks obsolescence. So unusually high liquidity ratios can signal inefficient use of resources rather than genuine strength, and management should consider putting the surplus to more productive use.
Why this scores
Marking (point-based, 4). Excess current assets (1); idle cash/inventory not earning return (2); inefficiency not strength (1).
Question 9
9706 Paper 3 style6 marks
Q (6 marks). A profitable company is growing its sales rapidly. Its working capital cycle has lengthened from 40 to 75 days and its acid-test ratio has fallen from 1.1 : 1 to 0.6 : 1. Discuss the risk facing the company and what it could do.
Model answer
The company shows the classic signs of overtrading: it is expanding sales rapidly but its working capital cycle has lengthened (40 → 75 days), tying up more and more cash in inventory and receivables, while its acid-test ratio has fallen well below 1 : 1 (1.1 → 0.6), showing weakening liquidity.

The risk is that, despite being profitable, the company may be unable to pay its short-term debts as they fall due — it could run out of cash even while reporting profits, potentially leading to insolvency.

To manage this, the company could: slow the rate of expansion to a level its working capital can support; tighten credit control to collect receivables faster; reduce inventory levels; negotiate longer credit from suppliers; and raise additional long-term finance (e.g. a loan or share issue) to fund the higher working capital needed. The key message is that profit is not cash — rapid growth must be financed.
Why this scores
Marking (point-based, 6). Identify overtrading (~2); risk — profitable but cash crisis/insolvency (~2); actions — slow growth/credit control/finance (~2).
Question 10
9706 Paper 3 style3 marks
Q (3 marks). Explain the difference between the current ratio and the acid-test ratio, and why the acid-test ratio is a stricter measure of liquidity.
Model answer
The current ratio (current assets ÷ current liabilities) includes all current assets, whereas the acid-test ratio ((current assets − inventory) ÷ current liabilities) excludes inventory. It is a stricter test because inventory is the least liquid current asset — it must first be sold (on credit) and then collected as cash — so the acid-test shows whether the business could meet its short-term debts without relying on selling its inventory.
Why this scores
Marking (point-based, 3). Current includes all (1); acid-test excludes inventory (1); inventory least liquid (1).

Key Formulae — Liquidity and Working Capital Management Ratios

The formulae you need to memorise for liquidity and working capital management ratios on the Cambridge IGCSE paper, with every variable defined in plain English and a note on when to use it.

Current ratio
$Current\ ratio = \frac{Current\ assets}{Current\ liabilities}$
$Current assets$
inventory + receivables + cash, etc.
$Current liabilities$
payables, overdraft, etc.
When to use
To measure overall short-term liquidity (X : 1).
Example
90,000 ÷ 50,000 = 1.8 : 1.
Acid-test (quick) ratio
$Acid\text{-}test = \frac{Current\ assets - Inventory}{Current\ liabilities}$
$Inventory$
the least liquid current asset, excluded
When to use
A stricter liquidity test, excluding inventory.
Example
(90,000 − 36,000) ÷ 50,000 = 1.08 : 1.
Inventory turnover
$Inventory\ turnover = \frac{Cost\ of\ sales}{Average\ inventory}$
$Average inventory$
(opening + closing) ÷ 2
When to use
To measure how quickly inventory is sold (times); × 365 ÷ result for days.
Example
300,000 ÷ 50,000 = 6 times.
Trade receivables days
$Receivables\ days = \frac{Trade\ receivables}{Credit\ sales} \times 365$
$Credit sales$
use credit sales where the split is given
When to use
To measure how long customers take to pay.
Example
(48,000 ÷ 400,000) × 365 ≈ 44 days.
Trade payables days
$Payables\ days = \frac{Trade\ payables}{Credit\ purchases} \times 365$
$Credit purchases$
use credit purchases where given
When to use
To measure how long the business takes to pay suppliers.
Example
(30,000 ÷ 250,000) × 365 ≈ 44 days.
Working capital (cash) cycle
$Cycle = Inventory\ days + Receivables\ days - Payables\ days$
$Inventory/receivables/payables days$
the three efficiency periods
When to use
To measure the time cash is tied up in working capital.
Example
61 + 44 − 44 = 61 days.

Key Definitions and Keywords — Liquidity and Working Capital Management Ratios

Definitions to memorise and the exact keywords mark schemes credit for liquidity and working capital management ratios answers — sharpened from recent examiner reports for the 2026 Cambridge IGCSE sitting.

Liquidity
Examiner keyword
The ability of a business to pay its short-term debts as they fall due.
Current ratio
Examiner keyword
Current assets ÷ current liabilities; overall short-term liquidity.
Acid-test (quick) ratio
Examiner keyword
(Current assets − inventory) ÷ current liabilities; a stricter liquidity test.
Inventory turnover
Examiner keyword
Cost of sales ÷ average inventory; how many times inventory is sold in a period.
Trade receivables days
Examiner keyword
(Trade receivables ÷ credit sales) × 365; average time customers take to pay.
Trade payables days
Examiner keyword
(Trade payables ÷ credit purchases) × 365; average time taken to pay suppliers.
Working capital (cash) cycle
Examiner keyword
Inventory days + receivables days − payables days; time cash is tied up in working capital.
Overtrading
Expanding faster than the available working capital can support, risking a liquidity crisis.

Common Mistakes and Misconceptions — Liquidity and Working Capital Management Ratios

The traps other students keep falling into on liquidity and working capital management ratios questions — taken from recent Cambridge IGCSE examiner reports and mark schemes — and how to avoid them.

✕Using revenue instead of cost of sales for inventory turnover
9706 Examiner Reports
Why it happens
Defaulting to sales.
How to avoid it
Inventory turnover uses COST OF SALES ÷ average inventory, not revenue.
✕Using total sales/purchases instead of credit figures
9706 Examiner Reports
Why it happens
Ignoring the split.
How to avoid it
Use CREDIT sales for receivables days and CREDIT purchases for payables days where the split is given.
✕Including inventory in the acid-test ratio
9706 Examiner Reports
Why it happens
Treating it like the current ratio.
How to avoid it
The acid-test EXCLUDES inventory (the least liquid current asset).
✕Adding payables days in the cash cycle
9706 Examiner Reports
Why it happens
Forgetting it is subtracted.
How to avoid it
Cash cycle = inventory days + receivables days − PAYABLES days (payables are subtracted).
✕Giving the number with no interpretation
9706 Examiner Reports
Why it happens
Stopping at the calculation.
How to avoid it
Explain what the ratio/change MEANS and what could be done — number → meaning → action.
✕Assuming a higher ratio is always better
9706 Examiner Reports
Why it happens
Equating high with safe.
How to avoid it
Too high a current ratio can mean idle resources; balance liquidity against efficiency.

Liquidity and Working Capital Management Ratios

Detailed Study Notes

At a glance

What you’ll learn

Quick recap

Memorise this

How it’s examined

Take this whole topic with you

1Current ratio (3 marks)

2Acid-test ratio (4 marks)

3Inventory turnover (4 marks)

4Receivables and payables days (5 marks)

5Inventory days (4 marks)

6Working capital cycle (4 marks)

7Interpret a falling current ratio (5 marks)

8Shortening the cash cycle (4 marks)

9Can liquidity be too high? (4 marks)

10Spotting overtrading risk (4 marks)

Current ratio

Acid-test (quick) ratio

Inventory turnover

Trade receivables days

Trade payables days

Working capital (cash) cycle

Liquidity

Current ratio

Acid-test (quick) ratio

Inventory turnover

Trade receivables days

Trade payables days

Working capital (cash) cycle

Overtrading

✕Using revenue instead of cost of sales for inventory turnover

✕Using total sales/purchases instead of credit figures

✕Including inventory in the acid-test ratio

✕Adding payables days in the cash cycle

✕Giving the number with no interpretation

✕Assuming a higher ratio is always better