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Many cash flow items have a direct counterpart, that is, an accrual item on the income statement. During a reporting period like a fiscal year or a fiscal quarter, the cash flow typically will not match its accrual counterpart. For example, cash spent during the year to acquire new inventory will not match cost of goods sold (COGS). This is because accrual accounting gives rise to timing differences in the short run: on the income statement, revenues count when they are earned, and they're matched against expenses as the expenses are incurred.
Expenses on the income statement are meant to represent costs incurred during the period that can be tracked either (1) to cash already spent in a prior period or (2) to cash that probably will be spent in a future period. Similarly, revenues are meant to recognize cash that is earned in the current period but either (1) has already been received or (2) probably will be received in the future. Although cash flows and accruals will disagree in the short run, they should converge in the long run, at least in theory.
Consider two examples:
• Depreciation - Say a company invests $10 million to buy a manufacturing plant, triggering a $10 million cash outflow in the year of purchase. If the life of the plant is 10 years, the $10 million is divided over each of the subsequent 10 years, producing a non-cash depreciation expense each year in order to recognize the cost of the asset over its useful life. But cumulatively, the sum of the depreciation expense ($1 million per year x 10 years) equals the initial cash outlay.
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