As a small business owner, we know you’ve got a lot on your plate. Between managing supplies and satisfying customers, the last thing you need to worry about is an accounting error (or any error for that matter). With the right processes and tools in place, you can be well equipped to handle any challenge that might come your way.
One essential part of running a small business is managing your internal accounting cycle and bookkeeping. Creating a clear picture of your company’s financial health can be daunting, but with an understanding of the accounting cycle and easy-to-use accounting tools , you can come prepared and continue doing what you love, so let’s get started.
What is the accounting cycle?
The accounting cycle is a series of 8 steps that an organization uses to identify, analyze, and record transactions and the accounting procedures of the company — it’s an accounting term that all business owners should know.
Through this 8-step process, accountants will use the accounting cycle as a checklist to run through a set of well-planned procedures to determine which step to perform next to complete the cycle. When completed correctly, the accounting cycle ultimately delivers an accurate set of financial statements.
Why does the accounting process matter?
The accounting cycle is the foundation of accounting practices in your company, it sets the bar for financial organization and consistency. Small businesses often operate on narrow profit margins, and access to cash may be limited. These businesses have less room for error. Following the accounting cycle helps the business owner stay on track by accomplishing several tasks at once and helps with organization, asset protection, and financial reporting.
Now let’s dive into this process a bit more.
- It keeps financial transactions organized
- Failure to account for all financial transactions can result in lost revenue, or a possible discrepancy on financial statements.
- It protects your assets from theft
- Businesses must invest in asset purchases and maintenance. Without assets, businesses can’t operate. The accounting cycle protects assets from loss and theft by keeping track of your assets and revenue.
- It makes financial reporting easier The accounting cycle requires accountants to review the general ledger and the trial balance before using the information to create the financial statements. When business owners can generate reliable financial statements, they can understand and manage their business better.
The accounting cycle’s 8 steps
As we noted above there are 8 steps to the entire accounting process. Think of each step as a pillar that stands all on its own, and when brought together delivers a comprehensive visual of a company’s financial standing (sort of like a company’s financial report card). The detailed steps of the accounting cycle can be seen below.
1. Identify your transactions
Bookkeepers or accountants are responsible for recording the transactions over the accounting timeline.
For example, a marina that sells boats will need to keep track of each transaction that is made through purchases of equipment, parts, or services rendered over the accounting period. They will also want to take note of important information to make categorizing and following steps easier.
Important info to identify includes:
- Transaction dates
- Product prices
- Amounts paid
2. Record the transactions
Storing information is a crucial part of the accounting process and can happen either at the point of sale (during the first step) or as a second step on its own. This can be done manually but many companies use accounting software for simpler storage recall and organization of transactions.
A few notes to remember when recording transactions:
- Maintain chronological order of transactions
- When using credits and debits, they must always balance each other out
- Include important notes for the accountant for easier reconciliation
- Luckily, accounting software can easily track all of this information for you.
3. Post transactions to the general ledger
Think of the general ledger as a summary sheet where all of the transactions live and are categorized. The general ledger is the master list of any transaction information listed in journals or sub-ledgers.
4. Create the trial balance
For the fourth step in the accounting cycle, transactions will need to be balanced at the end of the period. The accounting period can vary (monthly, quarterly, annually) depending on the company.
The trial balance provides the company with insight into the balances in the account and discovers any discrepancies. Since no accounting method is seamless you will almost always find some discrepancies when balancing your books.
5. Analyze the worksheet
Arguably one of the most intricate steps in the accounting process is the worksheet analysis. When you have credits and debits from your transactions that don’t balance (as in one cancels the other) you have to make corrective adjustments accordingly.
6. Adjust journal entries
The final step before you create your financial statements is making any adjustments, which need to be made to account for any corrections for accruals or deferrals. An example of an adjustment might be a salary or bill that is paid later on in the accounting period. Since it was recorded as an account payable when the cost originally occurred, it requires an adjustment to remove the charge.
7. Create financial statements
In this step, we generate financial statements—including the balance sheet, income statement, and cash flow statement—from the trial balance. Here’s a brief explanation of each financial statement and some must-know accounting formulas:
The balance sheet summarizes a company’s financial position as of a specific date. It’s a financial statement that subtracts assets from liabilities to determine equity:
- Assets – liabilities = equity
The most crucial part of the balance sheet is the profit and loss statement.
An income statement reports a business’s profit or loss over time—typically, a month or year. It’s a financial statement that subtracts revenue from expenses to determine net income or profit:
- Revenue – expenses = net income
Net income increases equity in the balance sheet. Many business owners focus on the balance sheet and income statements. But the cash flow statement is equally important.
The statement of cash flows reports cash inflows and outflows over time. Accountants or business owners can separate cash flow into three activities: operating, investing, and financing. The ending balance in the cash flow statement must equal the company’s cash balance on the balance sheet.
8. Close the books
Ask any accountant and they will confirm that finally closing the books is extremely satisfying. This happens at the end of each accounting period, signifying that the next accounting cycle can begin. Then we begin the accounting process all over at step 1.
5. Tips for successfully managing the accounting life cycle
With records and receipts strewn throughout your office, completing the accounting cycle can be a challenge. Use these 5 tips to improve your speed and accuracy.
Know your timing well
Whether your accounting period is done monthly, quarterly, or annually, timing is crucial to implementing the accounting cycle properly. Taking the time to map out plans and dates that coincide with your accounting deadlines will increase productivity and results.
Troubleshoot errors quickly
Having 8 steps in the overall accounting cycle may seem pretty straightforward, but it also means there are 8 chances for your process to go awry. Locating and solving problems early will be a defining task in making sure your process is carried out with much more ease and efficiency. This can be done by setting up proper procedures for each step, and creating checks and balances to catch unwanted errors along the way.
Modify the process to fit your needs
There is no one-size-fits-all solution when it comes to accounting practices. Each industry, company, and team operate differently. You may find early on that your system needs to be tweaked in order to accommodate your accounting habits.
For example, it can help to appoint one person to handle transactions because leaning on two or more could lead to discrepancies regarding which transactions are recorded to the proper accounts. It’s situations like these that can easily lead to an incorrect trial balance and risk delayed closing of your company books.
Set your team up for success
Give your staff the tools they need to succeed in implementing the accounting cycle. This could mean providing quarterly training on best practices, meeting with your staff each cycle to find their pain points, or equipping them with the proper accounting tools. The better prepared your staff is the more efficient they can be.
Try accounting software to lighten the load
Utilizing great tools to automate accounting processes will not only make your job easier but will also lessen the overall load that accompanies keeping your books. There are many tasks that can be automated and streamlined through the use of a business accounting platform; having your process go digital may seem daunting at first but will save you a lot of time in the long run.
Accounting cycle FAQ
We know the accounting cycle can seem daunting at times, so we wanted to cover common themes and answer your most urgent questions.
What is the most important step in the accounting cycle?
Each step in the accounting cycle is equally important, but if the first step is done incorrectly, it throws off all subsequent steps. If you’re unable to track your transactions accurately, the following steps won’t be able to create a clear accounting picture.
Why is the accounting cycle important?
The accounting cycle is important because it gives companies a set of well-planned steps to organize the bookkeeping process. It helps you avoid falling into the pitfalls of poor accounting practices.
Without the cycle, companies could risk going out of order, mishandling their records, and ultimately damaging their financial statements which could give a bad picture of the company’s financial health.
How many steps are in the accounting cycle?
Each company decides if they would like additional steps, but the accounting cycle typically includes these 8 steps:
- Identifying transactions
- Recording transactions
- Posting the general ledger
- Trial balancing
- Analyzing the worksheet
- Adjusting journal entries
- Producing the financial statements
- Closing the books
With accounting software, many of these steps are simplified, reducing errors that can come from manual processes. The accounting process is also significantly faster due to automation, saving time for small business owners and accountants.
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