Notice that profits in year t+1 depend on lagged production costs (ctxt) but cash flow depends on current production costs (ct+1xt+1). The parenthetical term in Eq(7) is the change in inventory, implying that CFt+1 differs from NIt+1 only because of inventory accruals. As discussed later, the model is easily adapted to include accounts receivable and payable or to add measurement error to accruals, but we focus initially on the model with only inventory accruals.