This diagram is based on analysis on a company making aircraft on a long-term contract.

It represents its revenue recognition over time.

If you are analyzing this company, understanding their contracts would be very important.

Contract accounting uses cost, cost, sometimes called percentage of completion method.

This manages the relationship between cash flows, costs, and revenues.

The company will be able to recognize revenue in proportion to the costs that it incurs.

Initially. This is very low, meaning low levels of revenue are recognized.

However, to help the company get established, its customer is committed to paying a relatively high early stage payment of cash.

This causes a mismatch between revenue and cash.

Since cash flows are higher than the revenue which can be recognized, this mismatch would be represented by a contract liability, which is functionally very similar to a deferred revenue later in the project.

As costs ramp up revenue recognition is high, but customer payments are relatively low.

This in isolation would be a contract asset, but in this case it would be a reduction in the contract liability.

Since it reverses the earlier mismatch, eventually cash and revenue will converge and the contract assets and liabilities would disappear.

'cause contract assets and liabilities are often included in operating working capital and 'cause contracts can be so material to industrials, working capital can be very volatile.

For this kind of company, having a good understanding of the company's contracts would be essential to explaining these large variations.