Navigating the financial landscape can be a challenge, especially if you’re setting up your first startup or running a small business. Among the many tasks that demand your attention, understanding and managing the accounting cycle stands out as critical and necessary.
This cyclical process involves identifying, recording, analyzing, and reporting your company’s monetary transactions in a systematic manner. In this guide, we’ll unravel its intricacies.
What is the Accounting Cycle?
The accounting cycle is a series of steps that businesses follow to record financial transactions and create accurate, reliable financial statements. Your recording requirements will determine the length of your accounting cycle, but most cycles will go through the same simple steps.
There are a few great reasons why you’d want to implement an accounting cycle:
- An accounting cycle will help you analyze the performance of your company.
- An accounting cycle can help you raise additional capital for your company.
- An accounting cycle will ensure that you follow your state’s laws and regulations.
Some businesses will only need 5 steps, while others require up to 10. However, we’re going to look at the 8 main steps you need to take. Make sure to add more if you need more wiggle room.
The 8 Steps of the Accounting Cycle
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The accounting cycle includes 8 vital steps that businesses follow to maintain accurate financial records and prepare their financial statements. Here are the 8 accounting steps.
Step 1: Identify Transactions
The first stage in the accounting cycle is to identify transactions. Running a business involves negotiating with multiple stakeholders, which results in various financial actions. These could be paying a service provider, receiving money from a client, or buying office supplies.
When these events take place during your operations, they are known as transactions, and start the ball rolling for the entire accounting process. Keep in mind that every transaction should have supportive documentation like invoices or receipts to maintain transparency and accuracy.
Step 2: Keep a Journal of Your Transactions
When making a general ledger entry online, you need to follow a structured process. Start by identifying the accounts involved and determine if it’s an increase or decrease in each account. Then, record the transaction in the general journal with the appropriate debits and credits.
Be sure to include the date, description of the transaction, and relevant account numbers. After journalizing the entry, transfer the amounts to their respective accounts in the general ledger.
This step ensures that all financial transactions are accurately recorded and organized for future reference. And If you have physical receipts, know that you can easily convert statements with this tool called DocuClipper. It simplifies and streamlines your documentation process.
Step 3: Make a General Ledger Entry
A general ledger entry is an essential tool for organizing your business’s financial information.
The general ledger is a master document that compiles, classifies, and summarizes all your financial transactions recorded in chronological order in individual journal entries. These are then transferred or ‘posted’ to the correct general ledger account so they can be used later.
For instance, if you made a cash purchase of equipment, this transaction would be posted as a debit in the Equipment account and credit in the Cash account of your general ledger.
Step 4: Have an Unadjusted Trial Balance Calculation
As your fourth move in the accounting cycle, you should perform an unadjusted trial balance calculation. This process is a tabulation of debits and credits from all transactions recorded into your ledger accounts till date. You can start this process after the period has finished.
It establishes that the total amount of debit account balances equals the total credit account balances, verifying the principle that for every debit entry, there’s an equivalent credit entry.
The primary purpose of this stage is to find and correct potential errors in your organization’s bookkeeping system before pushing forward with other steps in the accounting cycle.
Step 5: Make Adjusting Entries
Preparing adjusting entries is a necessary step if you want accounting accuracy, and to adhere to the accrual concept of accountancy. Your adjusting entries reflect income accrued but not yet received, and expenses incurred but not yet paid, in the accounting period under review.
For example, you might need to acknowledge interest earned on a bank deposit or recognize a utility bill charged, but not yet paid. By updating your books with these details, you ensure that your financial reports mirror your business’s financial position during that particular time frame.
Keep in mind that the depreciation expense is a standard business estimate. There are many things you own, like your equipment, that will depreciate over their estimated lifecycle.
Step 6: Review the Worksheets for Accuracy
Worksheets are internal documents that accountants use for compiling and analyzing all ledger accounts at the end of an accounting period. This is when you’ll closely examine all transactions recorded, check the adjustments made, and reconcile discrepancies found in your balances.
This careful examination ensures that your financial data is accurate and rightly coded before crafting key financial statements. For this reason, it’s important to review your sheets often. Remember, accurate financial data will always guide you toward smarter business decisions.
Step 7: Prepare Your Financial Statements
At this point, assuming all previous stages have been executed correctly, you’ll have an accurate representation of your company’s financial activities thanks to your statements.
Your financial statements typically include an income statement, balance sheet, and cash flow statement. Each of these reports serves a distinct purpose and provides unique insights into your business. Your accountants will use this to perform a wide variety of financial tasks.
Collectively, they paint a broad picture of your financial health, income sources, spending habits, asset management, and cash flow pattern over the evaluated accounting period.
Step 8: Put Your Books Away (or Start Again)
Now, you’re at the end of the accounting cycle. This is when you would close your books. However, since the accounting cycle is cylindrical, this is also where you’d start again.
When closing your books, you’re involved in closing your temporary revenue-controlling and expense-related accounts and transferring their balances to permanent accounts and records.
The primary purpose is resetting your income and expenditure records for the next accounting cycle. After these closures, your ledger would clearly outline only your business’s retained earnings and collected capital, ensuring its readiness to record new financial transactions.
Now that you understand the accounting cycle, it’s time to put this knowledge into action! Our steps will help restore order, clarity, and confidence in your financial management process.
Remember, mastering your company’s bookkeeping can unlock paths to better decision-making, enhanced operational efficiency, and more growth opportunities. Every stride you make in comprehending your business finances is a step closer to reaching entrepreneurial success.