Accounting Basics for Investors#

You don't need to become an accountant to read financial statements. But understanding a few key concepts will help you interpret what you're reading and avoid common mistakes.

This lesson covers the "ground rules" of financial statements—the basic accounting concepts that determine how numbers are recorded and reported.

Accrual vs. Cash Accounting#

This is perhaps the most important concept for investors to understand: reported profits don't always equal cash.

Cash Accounting#

Cash accounting records transactions when cash changes hands:

Revenue recorded when payment received
Expenses recorded when payment made
Simple and straightforward

Accrual Accounting#

Accrual accounting records transactions when they're earned or incurred, regardless of when cash moves:

Revenue recorded when earned (even if not yet paid)
Expenses recorded when incurred (even if not yet paid)
Required for public companies

Why This Matters

A company might show $1 million in revenue, but if customers haven't paid yet, that money isn't in the bank. This is why you need to look at the cash flow statement, not just the income statement.

Example: The Timing Difference#

Imagine a company sells $100,000 of products in December but doesn't get paid until January:

Accounting Method	December Revenue	January Revenue
Accrual	$100,000	$0
Cash	$0	$100,000

Both eventually record the same total, but the timing is different. Public companies use accrual accounting, so you might see revenue before cash arrives.

GAAP: The Rules of Accounting#

GAAP stands for Generally Accepted Accounting Principles. These are the standardized rules that companies must follow when preparing financial statements.

Why GAAP Matters#

Without standard rules, every company could report numbers differently, making comparisons impossible. GAAP ensures:

Consistency - Same rules apply to all companies
Comparability - You can compare Apple to Microsoft
Transparency - Clear guidelines for what to report
Reliability - Auditors can verify compliance

GAAP vs. Non-GAAP#

Companies often report both GAAP and "non-GAAP" or "adjusted" numbers:

Type	What It Is
GAAP	Official numbers following accounting rules
Non-GAAP	Adjusted numbers that exclude certain items

How to Handle Non-GAAP

Non-GAAP numbers can be useful for understanding ongoing operations (excluding one-time events). But be skeptical—companies can use non-GAAP to make results look better than they are. Always compare both.

Fiscal Year vs. Calendar Year#

Not all companies end their financial year on December 31.

Calendar Year#

January 1 to December 31
Most companies use this

Fiscal Year#

Any 12-month period chosen by the company
Often aligned with business cycles

Common Fiscal Year Ends#

Company Type	Common Fiscal Year End	Reason
Retailers	January 31	After holiday season
Government contractors	September 30	Matches federal fiscal year
Schools/Universities	June 30	Matches academic year

Apple's fiscal year ends in late September, while Microsoft's ends in late June. Keep this in mind when comparing quarterly results—their Q1 represents different calendar months.

Quarterly vs. Annual Reporting#

Public companies report financials on two schedules:

Quarterly Reports (10-Q)#

Every three months
Unaudited
Less detailed
More timely

Annual Reports (10-K)#

Once per year
Audited
Comprehensive
More reliable

The Four Quarters#

Quarter	Typical Months (Calendar Year)
Q1	January - March
Q2	April - June
Q3	July - September
Q4	October - December

Audited vs. Unaudited Statements#

An audit is an independent verification of financial statements by a certified accounting firm.

Audited Statements (10-K)#

Verified by independent auditors
Auditors test samples of transactions
Auditors verify numbers tie out
Includes auditor's opinion letter

Unaudited Statements (10-Q)#

Prepared by company's own accountants
Not independently verified
Required disclosure of material changes
Generally reviewed (not audited) by external firm

Auditor's Opinion

Look for the auditor's opinion letter in the 10-K. A "clean" or "unqualified" opinion means the auditors found no significant issues. Any other type of opinion is a yellow flag worth investigating.

Key Accounting Terms for Investors#

Term	Meaning
Depreciation	Spreading the cost of assets over their useful life
Amortization	Similar to depreciation, but for intangible assets
Accrued	Recorded but not yet paid
Deferred	Received but not yet earned
Provisions	Estimates for future costs (like warranties)
Impairment	Writing down the value of an asset

What You Don't Need to Know#

Good news: you don't need to understand every accounting nuance. Focus on:

What matters:

The big picture trends
Cash flow reality
Comparing to competitors
Major changes from prior periods

What you can skip:

Complex footnote calculations
Technical accounting debates
Minor adjustments and reclassifications

Key Takeaways

Accrual accounting records revenue when earned, not when cash is received
GAAP provides standardized rules for financial reporting
Companies may use different fiscal years—check dates when comparing
Annual (10-K) reports are audited; quarterly (10-Q) reports are not
Non-GAAP numbers can be useful but should be viewed skeptically
Focus on understanding trends and cash flow, not accounting minutiae