Picture this: an investor wants to see your income, cash flow, and balance sheets before they agree to fund you. However, you only close your books once a year to file tax returns and don’t have the latest information on your financial health.
You’re stressed and rushing to put together these documents. Even if you’re closing your books monthly, depending on the time of month, you’re still left in a bind.
What if things could be different?
That’s where the accounting cycle comes in. Mastering the accounting cycle for your startup is essential if you want to avoid unnecessary workload when closing your books, prevent inaccurate financial data, and minimize tax burden.
Following the accounting cycle step-by-step gives you a better handle on your company’s financial health, sets the stage for access to the capital you may need to grow, and ensures that your books are in tip-top shape.
Read on to learn everything you need to know.
What Is The Accounting Cycle?
The accounting cycle is a series of steps business owners follow through a predetermined period to keep their books in order. The steps of the accounting cycle are as follows:
- Analyze business, accounting, and financial transactions
- Record transactions in the accounting journal
- Post transactions to the expense ledger
- Determine the unadjusted trial balance
- Find any errors in the worksheet
- Fix any errors in journal entries
- Generate financial statements and close the books
While most accounting periods last an entire year, it is good practice to work through the accounting cycle daily and complete it every month.
This type of accounting, known as full-cycle or operating-cycle accounting, ensures your financial reports are error-free and up-to-date and that your closings run smoothly.
Why The Accounting Cycle Is Crucial For Startups
There are several reasons the accounting cycle can make or break your startup. Most importantly:
- Access To Capital – Securing funding requires solid financial reporting to potential investors or creditors, including your income, cash flow, and balance sheets. A full accounting cycle ends with producing these documents and ensuring their accuracy.
- Stay On Top Of Credit Balances – When participating in operating cycle accounting, you’ll always know where your credit balances lie. You’ll also likely find opportunities to optimize your use of credit and improve your company’s financial health.
- Growth Opportunities – When you follow the accounting cycle, you’ll constantly be in the know when it comes to your company’s financial performance. As such, you can act quickly when opportunities to improve your performance arise.
The Stages of the Accounting Cycle
The accounting cycle consists of seven accounting events. Each event takes you one step closer to closing your books. Find the steps in the accounting cycle below.
1. Analyze Business, Accounting, and Financial Transactions
First, you’ll need to assess your business’s financial activities:
- Identify Accounts – Identify the accounts involved in each transaction within a set period.
- Identify The Nature Of These Accounts – Did the transaction happen in asset, liability, or stakeholder equity accounts?
- Identify Gains & Losses – Determine where the money involved in the transaction came from and where it went.
- Double-Entry Accounting – Apply double-entry accounting rules. These rules stipulate that every debit must have a corresponding credit in another account.
2. Record Transactions in the Accounting Journal
Now that you have all the information involved in each transaction, it’s time to record your transactions in your accounting journal (general ledger). It helps take the guesswork out of accounting entries by allowing you to track them immediately.
Pro tip: Always record transactions chronologically to keep your books well organized.
3. Post Transactions To the Expense Ledger
As you work through the accounting process, you’ll work in different ledger accounts. One is known as the expense ledger. This is where you record all business expenses as they happen.
This matters for two reasons:
- Taxes – You don’t pay taxes on the portion of your revenue you use to cover business expenses. Therefore, items in the expense ledger reduce your tax burden.
- Optimization Opportunities – Keeping a regular pulse on your expense ledge will give you a better idea of how to optimize your spending moving forward.
4. Determine Unadjusted Trial Balance
Once you post all transactions to your ledgers, determine your adjusted trial balance. This is a list of all the accounts that appear in your general ledger, along with their balances, after you make any adjustments needed.
In this step, you’ll make sure that total debits match total credits in your financial records. This checks-and-balances step helps guarantee accuracy in your financial records.
5. Find Any Errors in the Worksheet
After you adjust your trial balance, use a worksheet to determine whether or not all individual debits match all individual credits. This process will be much easier because you recorded transactions chronologically in your accounting journal.
In this step, you’re looking for errors in the worksheet where individual credits don’t match individual debits.
6. Fix Any Errors in Journal Entries
If you find any individual credits that don’t match the corresponding individual debits, you’ll need to make adjustments to make these match. That means you'll need to figure out why the items don't match and why any inaccurate transactions were recorded as they were. Once you figure it out, accurately record your financial data.
7. Generate Financial Statements and Close the Books
As soon as everything matches, you'll enter your closing entries. Closing entries are your final, factual figures. You'll use these entries to create your financial reports, such as your balance sheet, cash flow statement, and income statement.
How Real-Time Accounting Fits Into The Picture
Some suggest that the accounting cycle is worked on once per year. However, to keep your books in the best shape possible, you should work through the monthly accounting cycle and take daily steps to keep your books in order.
That’s where real-time bookkeeping comes in.
When you update your books each time a transaction happens, you know that whenever you look at your financial statements, they’re accurate. Of course, doing this manually is a cumbersome task, so you’ll want to take advantage of accounting software to keep your books in order.
How Accounting Software Can Help
Technological innovation has changed how we do almost everything. It has also made accounting far more manageable. Taking advantage of accounting software alleviates the need for daily mundane, time-consuming tasks to keep your books in good shape.
Today’s accounting technologies feature integrations and automation to simplify real-time accounting so every business owner can keep their books in good standing. Consider purchasing quality accounting software to save time and keep your books in order every single day.