Significance

• Every year, it's worth a little less.tractor image by Alison Bowden from Fotolia.com
  
  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 Management Care

• Replacement tractorindustrial_18 image by Aleksandr Popov from Fotolia.com
  
  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. In "Financial Management Theory and Practice," Eugene F. Brigham and Louis C. Gapenski note 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 lots of non-cash items.pen showing diagram on financial report/magazine image by Anton Gvozdikov from Fotolia.com
  
  There are dozens of non-cash items that may appear on an income statement, according to "The 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.
  
  

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, according to "The Accountants' Handbook." 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

• Sometimes there are red flags.red flags image by Stepanov from Fotolia.com
  
  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.