A trader pays SAR 100,000 cash for goods, then sells a portion costing SAR 60,000 for SAR 90,000 on credit. Gross profit looks healthy at SAR 30,000. Yet the bank balance has fallen by SAR 100,000 and no cash has arrived from the customer. Neither report is necessarily wrong: each answers a different question, with inventory connecting the two.
This educational case excludes taxes, other expenses and opening balances to make the relationship clear. The trader retains inventory costing SAR 40,000, has a SAR 90,000 receivable and has earned SAR 30,000 gross profit. However, the purchase was funded in full before any sales proceeds were recovered. A profit report alone cannot tell the trader when the next order can be paid for.
Read the transaction across three dates
On the purchase date, cash becomes goods. On the sale date, the sold portion's cost moves from inventory into cost of sales, while a receivable arises instead of an immediate cash receipt. On the collection date, that receivable becomes a bank balance. Collection does not generate a second sale for the same transaction.
These dates might fall within one month or stretch across several. The longer the intervals, the greater the funding needed to support the cycle, even when sales are growing. “How much did we sell?” therefore needs companion questions: how much was paid to suppliers, how much remains in the warehouse, and how much is due from customers but uncollected?
IAS 7 supports distinguishing profit from cash movements. Its indirect approach explains the effect of non-cash items and accruals on operating cash flows. In this simplified case, start with SAR 30,000 profit, subtract the SAR 90,000 increase in receivables and the SAR 40,000 increase in inventory. The result is a SAR 100,000 outflow. This is an educational reconciliation for one transaction, not a complete statement for an actual business.
Supplier credit postpones pressure rather than eliminating it
Suppose the supplier agrees to collect SAR 100,000 after 45 days. No payment leaves on the purchase date, making the due-date calendar more informative than today's bank balance. If the sale takes place ten days after purchase and the customer pays 60 days after sale, expected collection is on day 70. The supplier still falls due on day 45.
There is a 25-day gap between payment due and expected collection. Furthermore, collecting SAR 90,000 does not fully cover a SAR 100,000 supplier invoice. Another SAR 10,000 must come from elsewhere until more inventory is sold or other cash arrives. Credit terms improve timing without making the entire purchase self-funding.
A volume discount can consume more cash than it saves
A supplier may offer a discount for doubling the order. Before accepting, compare the saving with the extra cash tied up in goods, the length of time it will remain tied up and the risk of later price reductions. The point is not to reject discounts, but to avoid evaluating them through unit price alone.
Ask sales staff for evidence of additional demand rather than general optimism. Review storage capacity, handling, shelf life and substitutes already held. Split deliveries or a smaller minimum order might help liquidity more than a larger discount that fills the warehouse with unwanted stock.
For weekly monitoring, prepare a short schedule of approved purchases and payment dates, expected sales and forecast collections with an explicit confidence level. Attach supporting evidence and a responsible follow-up owner to major receipts. Do not fund a committed order with a possible sale that has not become a customer order. When collection slips, explain the change instead of silently moving its date in the forecast.
Good inventory is not necessarily the lowest inventory: shortages can lose valuable sales. The aim is a quantity that serves demand at an appropriate margin without unnecessarily immobilising cash. Bringing accounting, purchasing and sales together around the same timeline makes that trade-off visible, rather than allowing each department to improve its own number while the business becomes less able to pay.
Sources & further reading
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General educational content. Appropriate treatment depends on your business and accounting policies; consult your accounting professional when applying it to business records.
