What Is a Non-Cash Item?

What Is a Non-Cash Item?

Let me explain what a non-cash item means, as it has two distinct definitions depending on the context. In banking, you should know it as a negotiable instrument, like a check or bank draft, that gets deposited into your account but isn't credited until it clears the issuer's account.

On the other hand, in accounting, a non-cash item is an expense you see on an income statement—things like capital depreciation, investment gains, or losses—that doesn't actually involve any cash payment.

Understanding Non-Cash Items

Let's dive into the accounting side first. Income statements are tools companies use in their financial statements to show investors how much money they made and lost. These can include several items that affect earnings but not your cash flow. That's because accrual accounting measures income by including transactions without cash payments, giving you a more accurate view of the current financial condition.

You'll find examples like deferred income tax, write-downs in the value of acquired companies, employee stock-based compensation, as well as depreciation and amortization.

Now, shifting to banking: Banks often place a hold of up to several days on large non-cash items, such as checks, based on your account history and details about the payor—for instance, whether the issuing organization can cover the check.

That brief period when both banks have the funds available—between the check being presented and the money withdrawn from the payor's account—is known as the float.

Depreciation and Amortization Example

Depreciation and amortization are the most common examples of expenses that cut taxable income without touching cash flow. Companies account for the declining value of assets over time through depreciation for tangible items and amortization for intangibles.

Take this scenario: Suppose a manufacturing business, Company A, spends $200,000 on new high-tech equipment to increase production. The equipment is expected to last 10 years, so the accountants suggest spreading the cost over its useful life instead of expensing it all at once. They also consider a salvage value of $30,000 after 10 years.

Depreciation matches revenue with associated expenses. By dividing $170,000 by 10, the equipment shows up as a $17,000 non-cash expense each year for the next decade. No actual money leaves the company when these expenses are recorded, so they appear as non-cash charges on income statements.

Special Considerations

Non-cash items show up often in financial statements, but investors sometimes ignore them and assume everything is fine. As with all financial accounting, it's wise to approach them skeptically.

One major risk is that these items rely on estimates influenced by past experiences. Users of accrual accounting have been found, intentionally or not, to inaccurately estimate revenues and expenses.

For instance, Company A's equipment might need to be written off before 10 years or last longer than expected. The salvage value estimate could be off too. Eventually, businesses must update and report actual expenses, which can cause significant surprises.