The principle of revenue and expense transaction has been created to prevent mismatching that can occur when recording transaction on cash-flow basis. In a nutshell, revenues need to be matched with relevant expenses in certain period. This is known as revenue recognition which is then matched with expenses that has been incurred in order to generate that revenue. Therefore, accrual accounting is the preferred way of recording revenues, because it matches revenues with expenses as opposed to cash flow accounting.

In my opinion revenue recognition is potentially most dangerous yet easiest to implement by creative managers. For instance, excessive trade receivables recognition in order to boost EPS and cash in nice bonus. This very short-term technique can bring an organisation to its knees.

Therefore, if trade receivables (accrual accounting) grow substantially quicker than cash from operations (true cash to the business) then this could be a “red flag” demanding cautious investigation of the financial statements.