It’s vital to understand the two primary accounting methods – accrual and cash accounting. The difference between them is when revenues and expenses are recognised. Accrual accounting records revenues when earned and expenses when incurred, regardless of cash flow. It follows GAAP’s revenue recognition and matching principles, making it the preferred method for most companies.
On the other hand, cash accounting only records cash transactions, which means revenues are recorded when cash is received, and expenses are recorded when cash is paid. Although cash accounting is more straightforward, it doesn’t accurately reflect a company’s financial health as it ignores outstanding receivables and payables. To become proficient in reading and analysing financial statements, it’s crucial to understand these accounting concepts and principles. They provide a framework for interpreting essential financial information that can be used for various purposes, such as decision-making and investment analysis.