Accruals and Working Capital
The four kinds of accrual that separate profit from cash, how to measure the cash a company's daily operations tie up, and why the estimates inside accruals deserve attention.
The short version
An accrual is the gap between when something is recorded and when the cash moves. There are four kinds: sales not yet collected, costs not yet paid, cash paid before the cost is recorded, and cash collected before the sale is recorded. Together they make up working capital, the cash tied up in running the business day to day. Days of receivables, inventory, and payables turn those balances into something comparable across years and companies, and the cash conversion cycle adds them into one number. A growing company usually needs more working capital, which uses cash. Many accruals are estimates, so they're also where profit can be nudged up or down.
By the end of this lesson, you'll be able to
- Name the four kinds of accrual and where each sits on the balance sheet
- Calculate days of receivables, inventory, and payables, and the cash conversion cycle
- Explain how accrual estimates can shift profit between years
Why this matters
Why Earnings and Cash Differ showed that timing is one of the main reasons profit and cash come apart. This lesson goes into that timing. It matters for two reasons. The balances involved decide how much cash a business needs just to operate, and they're built partly on estimates, which makes them the easiest place to adjust a profit figure.
Four kinds of accrual
Financial statements use Accrual accounting. Recording sales and costs in the period they happen, whether or not the cash has moved yet. It's why a company's profit and its cash flow differ. Glossary: transactions are recorded in the period they happen, even if the cash is received or paid in a different one.1 Whenever the record and the cash fall in different periods, a balance appears on the balance sheet to hold the difference. There are four cases.
| What happened | Balance sheet line | Effect |
|---|---|---|
| Sale recorded, cash not yet collected | Accounts receivable. Money customers owe a company for products or services already delivered but not yet paid for. Glossary (asset) | Profit ahead of cash |
| Cash paid, cost not yet recorded | Inventory. Materials, unfinished products, and finished goods a company holds for making and selling. Glossary, prepaid expenses (assets) | Profit ahead of cash |
| Cost recorded, cash not yet paid | Accounts payable. Money a company owes its suppliers for goods or services it has already received. Glossary, accrued expenses (liabilities) | Cash ahead of profit |
| Cash collected, sale not yet recorded | Deferred revenue. Money customers have paid in advance for products or services not yet delivered. It's a liability until the company delivers, when it becomes revenue. Glossary (liability) | Cash ahead of profit |
The first two use cash: the company has earned or bought something it hasn't been paid for or hasn't sold. The last two provide cash: suppliers, employees, and customers are, in effect, lending to the company for a while.
Working capital
Add the first two and subtract the last two, and the result is operating Working capital. Current assets minus current liabilities: a quick measure of a company's short-term financial room to maneuver. Glossary: the net cash tied up in day-to-day operations. For STU Corp, the fictional company from Part 3:
| This year | Last year | Change | |
|---|---|---|---|
| Accounts receivable | 50 | 44 | +6 |
| Inventory | 45 | 40 | +5 |
| Accounts payable | (30) | (27) | (3) |
| Accrued expenses | (10) | (9) | (1) |
| Deferred revenue | (15) | (12) | (3) |
| Operating working capital | 40 | 36 | +4 |
Working capital rose by $4 million, so operations absorbed $4 million of cash. That's exactly what the cash flow statement shows: the five working capital lines in STU Corp's operating section add up to a $4 million outflow. The cash flow statement reports the changes. The balance sheet shows the levels.
Working capital is 10% of STU Corp's $400 million of revenue. As a rough guide, that means each extra $100 of sales ties up about $10 of cash before any profit arrives. Fast growth can leave a profitable company short of cash for this reason alone.
The rest of this lesson is for members
Still to come in this lesson: Turning balances into days, When working capital is negative, The estimates inside accruals, the key takeaways, and 2 quiz questions with explanations.
Membership opens every lesson in the curriculum, the capstone projects, the interactive tools, and the members-only channels in the Hyperion Entities Discord. The first lesson of every module stays free.
Go deeper
- Depreciation, Amortization, and Capital SpendingFinancial Statement Analysis in Depth (depth track)
- Quality of EarningsFinancial Statement Analysis in Depth (depth track)
- Accounting Red FlagsFinancial Statement Analysis in Depth (depth track)
Learn more
- Beginners' Guide to Financial StatementsU.S. Securities and Exchange Commission
Notes and sources
- Financial Accounting Standards Board. Concepts Statement No. 8, Conceptual Framework for Financial Reporting, Chapter 1 (as amended). Checked 2026-10-11. Back to text
- U.S. Securities and Exchange Commission. The "Numbers Game": remarks by Chairman Arthur Levitt, NYU Center for Law and Business (September 28, 1998). Checked 2026-10-11.