The accounting cycle involves a few important steps that take all your business activities and turn them into clear, useful financial data. Consider these steps as the backbone of your whole financial management system. They work like a translator, changing the language of your business deals into a financial story that everyone can understand.
The accounting cycle is less complex than it may sound and an easily understood and logical process. Keep reading for a thorough explanation of the nine accounting cycle steps and their intrinsic flow.
What Is the Accounting Cycle?
The financial accounting cycle, a crucial procedure used to record, manage, and report a business’s financial information, is an ongoing process that starts with the simple recording of an individual business transaction and culminates in the creation of comprehensive financial statements.
These accounting procedures take into account all financial activities during a set accounting period, from sales and purchases to expenses and accounts receivable. These accrual accounting transactions are systematically recorded in a journal, which serves as a chronological rundown of all business transactions.
These journal entries then get posted to a ledger, a repository that tabulates all the individual transactions initially recorded in the journal. This is used to create an unadjusted trial balance, a record of all ledger accounts and their respective balances.
You then make adjustment entries that correct inaccuracies, include unrecorded transactions, or account for post-accounting period events. This gives you an adjusted trial balance, which reflects updated balances after consideration of the adjusting entries.
Next in line is preparing the financial statements, exhaustive reports that encapsulate the company’s financial health, including the balance sheet, income statement, cash flow statement, and retained earnings statement. You can then “close the books” and transfer all balances from temporary income statement accounts to permanent balance sheet accounts.
The accounting cycle isn’t a one-and-done deal. It’s a recurring process, vital for maintaining the accuracy and reliability of a company’s financial data, and continues to work its magic every accounting period.
A Step-by-Step Process of the Accounting Cycle
1. Collect and Analyze Source Documents
At this initial stage, you’ll gather and interpret all financial source documents, such as invoices, receipts, and bank statements. By analyzing these records, you’ll identify the different types of business transactions during the accounting period and determine their monetary value.
2. Journalize Transactions
Once you’ve fully analyzed the source documents, it’s time to record transactions by making journal entries for each one. In a process called “double-entry bookkeeping,” every financial event in a given period of time is recorded as a debit and a credit in two separate accounts. This process ensures the company’s books always balance at the end of the accounting period.
3. Post to the General Ledger
After journalizing, the next step in the accounting process is to post transactions to the general ledger. This bookkeeping tool categorizes and summarizes all the transactions. Posting to the general ledger helps consolidate all financial data and provides a clearer overall picture of expense accounts, credit balances, and the company’s financial health.
4. Prepare a Trial Balance
This step is all about verifying the accuracy of your financial entries. You’ll prepare a trial balance by listing all the company’s accounts and end balances, then ensuring the total debits equal the total credits. If they don’t, you’ll have to hunt down and rectify the discrepancy before moving on.
5. Make Adjusting Entries
Adjusting entries helps correct any accounting errors or omissions and aligns the books with the reality of the company’s financial situation. These might include prepaid expenses, unearned revenues, or accrued expenses. By correcting these discrepancies, your financial records become accurate and up to date.
6. Prepare an Adjusted Trial Balance
After adjusting entries, you’ll need to create a fresh trial balance incorporating these changes. This will confirm that the total debits still equal the total credits and provide a final check before creating the financial statements.
7. Create Financial Statements
Drawing from the adjusted trial balance, you’ll put together comprehensive financial statements, typically through accounting software. These are essential for demonstrating the company’s financial condition. They typically include an income statement, a statement of retained earnings, a balance sheet, and a statement of cash flows.
8. Close the Books
Closing the books means resetting your temporary accounts (like revenues, expenses, and dividends) to zero in preparation for the next accounting period. These temporary account balances are then transferred to permanent accounts in the company’s balance sheet.
9. Prepare a Post-Closing Trial Balance
The cycle concludes with a post-closing trial balance, which lists all the permanent accounts and their final balances after you’ve closed the books. This process prepares the company’s financial records for the next round of accounting. It also ensures the total debits still match the total credits and gives a sneak peek into the company’s financial standing for the next period.
Efficient Accounting Cycle Management for Startup Success
Mastering the accounting cycle is vital for any startup aiming to thrive in today’s competitive business landscape, no matter your business model.
By understanding and properly managing each step of this cycle, from collecting and understanding source documents to preparing complete financial reports, you’re laying down a sturdy foundation for informed decision-making by stakeholders and business owners.
Effective accounting cycle management allows your startup to track its financial health accurately, anticipate potential challenges, and identify areas for growth and investment.
These accounting methods build consistency and reliability in your financial transactions, critical factors for gaining trust from stakeholders, investors, and clients. Discover how a financial operations platform can help your startup approach finances in a whole new way.
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