Non-cash items on a company's financial statement are things that do not involve the use of cash. Recording non-cash items helps track such things as the wear and tear of expensive property and changes to the value of investments that haven't been sold. Non-cash items are found on the income statement portion of the financial statement.
Significance of Non-Cash Items
The income statement is one of the tools companies use to tell investors how much money they have made or lost. In the accrual form of accounting, companies measure their income by including transactions that are not based in cash. Consider, for example, the wear and tear on equipment. Imagine a very small company whose only asset is a tractor. Like an automobile, every year the tractor is worth less and less money. Keeping track of the tractor's decline in value is called depreciation. Depreciation subtracts from income, but it doesn't involve the use of cash.
Why Investors and Managers Care
At some point, the tractor will break. Its worth will only be its salvage value. An investor in the company will want to know one thing: whether the company has enough money to get another tractor. The book "Financial Management Theory and Practice" notes that some companies may use the depreciation expense as a means of calculating how much money it may need to set aside to replace its assets. Remember, the tractor is the only asset of the company, and without it, the company has no means to perform its work. If the company does not have the money for a new tractor, it is difficult to say that the company is profitable.
Other Types of Non-Cash Items
There are dozens of non-cash items that may appear on an income statement, according to "Accountants' Handbook: Financial Accounting and General Topics." Aside from depreciation, other non-cash items include amortization, unrealized gains or losses from investments, allowances for doubtful accounts or returns and write-downs of inventory.
Other examples include stock-based compensation given to employees, write downs in the value of acquired companies and deferred income tax that must be paid in the future.
Uses of Non-Cash Items
The income statement helps track changes to the value of a company over a period of time. The cash flow statement is used to determine how much cash a company has brought in over the same period. Accountants subtract non-cash items from an income statement to develop the statement of cash flows. For example, accounts receivable is money a company is owed for goods or services; it is not money received. Nevertheless, it has value, and is counted as income and appears on the income statement, but it is a non-cash item. When developing a statement of cash flows, accountants track changes to accounts receivable.
Red Flags in Non-Cash Items
Almost all companies use non-cash items in financial statements, but there are aspects of them of which investors should be wary. Non-cash items often involve the use of estimates. Imagine, for example, that a company expects some of its products to be returned for warranty repairs. The amount varies according to sales and prior experience. To account for this, a company calculates an allowance for warranty returns, a non-cash item that decreases income. An estimate that is too high will decrease more income, and thus make the company potentially less attractive to investors. An estimate that is too low will can cause problems down the road when the company must account for warranty work that was actually done.
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