8 Steps in the Accounting Cycle

By April 14, 2021 Business Advice
accounting cycle

Running a business of any size is a complex task. Successful business owners must juggle a variety of tasks each day including customer service, managing employees, marketing, and bookkeeping tasks.

Keeping track of bookkeeping may seem tedious, but lost opportunities and lost money can be devastating for small businesses. According to the Chamber of Commerce, most small businesses fail because of poor cash flow, poor planning, and bad management practices. These problems can be avoided by developing a sound business plan and implementing an effective accounting system.

Standard Accounting Practices

There is a set of “generally accepted accounting practices” (GAAP) used in the creation of financial documents. Standardized accounting procedures and guidelines set the expectation that financial statements will be reliable, verifiable, and objective. While details differ from business to business, a standard accounting cycle is recognizable to anyone with bookkeeping or accounting experience. 

Follow these Steps for Accurate Accounting

Following the accounting cycle allows business owners to track, measure, and accurately record financial transactions. Each step relies on the ones before it to provide an accurate picture of a business’s financial activity. Skipping a step (or two) will result in errors that can cripple a business. Depending on the nature of your business, there can be a range of steps in the accounting cycle. 

The following accounting cycle steps can be used by most small business owners:

1. Identify Transactions

The first step in the accounting cycle is gathering the financial records for the current accounting period. All of the financial transactions that have occurred need to be identified no matter how small they might be. Supporting documents include receipts, invoices, bank statements, credit card statements, and payroll information.

2. Prepare Journal Entries

The journal is where business transactions are initially recorded. It’s a running list of all financial activities, basically like a checkbook. Transactions should be recorded chronologically as they happen. Computerized accounting systems have largely replaced the physical journals of the past but the process remains the same.

3. Post Entries in General Ledger

The general ledger is also known as the book of final entry. The ledger is a large, numbered list showing all business transactions and how they affect each individual account. 

Using the journal, transactions are organized into different accounts. For example, if a customer pays with cash, the transaction is entered under the cash account in the general ledger. If you use accounting software, posting to the ledger is usually done automatically in the background.

4. Prepare a Trial Balance

A trial balance is prepared by totaling the debits and credits from the general ledger accounts, ensuring that the debits equal the credits. This step is necessary in order to detect and correct any errors that may have occurred during the initial stages of the accounting cycle. 

If the sum of the debit entries in a trial balance doesn’t equal the sum of the credits, that means there’s been an error in either the recording or posting of journal entries. If you use accounting software, this usually means a mistake was made in inputting information into the system.

5. Prepare Adjusted Entries

When the trial balance indicates that the general ledger accounts are not in balance, bookkeepers or accountants look for errors and discrepancies in order to correct them. These corrections are called adjustments, which are tracked on a worksheet, ensuring that debits and credits are equal.

6. Prepare an Adjusted Trial Balance

After the new entries are made, a new trial balance is calculated to test if the debits are equal to the credits. The trial balance shows the balance of all the accounts, including any adjusted entries at the end of an accounting period. If any errors are found in the adjusted trial balance, they should be immediately corrected.

7. Create Financial Statements

Once accounts are up-to-date, financial statements can be created. The following are common financial statements needed by small business owners:

  • Income statements compare your profits and losses for the time period.
  • Balance sheets determine progress by detailing assets, liabilities, and owner equity.
  • Cash flow statements show money coming into and going out of the business.

Financial statements are used to measure performance, make improvements, and set new goals. These statements are also critical pieces of information for lenders and investors.

8. Close the Books

At the end of an accounting cycle, the books are closed in order to start a new cycle. The purpose of the closing process is to make sure that income or expenses from a previous accounting period don’t carry over to the next accounting period, thus creating inaccurate figures. 

Small business owners need to close their books at year-end in order to properly file income tax returns. Closing the books on a monthly basis is a common practice for many businesses. 

Get Accounting Assistance

There’s a lot to keep in mind when moving through an accounting cycle and if you’re new to the process, it can feel overwhelming. Keeping track of documentation, correctly entering transactions, reconciling bank statements, and balancing accounts can be time-consuming unless you have bookkeeping expertise. 

Even if you use accounting software to simplify the process, it’s important that the people inputting and reviewing the data are properly trained. If you don’t have the time or personnel to handle your bookkeeping tasks, outsourcing can be a cost-effective way to ensure your accounts are always in order. 

Orcutt & Company is a full-service financial solutions provider. Our comprehensive service plans are designed with the small business owner in mind. 

We can handle your bookkeeping, payroll, and corporate and personal taxes in one office, with one point of contact. Our integrated approach is designed to ensure that we understand your personal and business goals and how they integrate with your business finances. 

Consultation is fundamental to all our business services. Through our annual review with owners, we look at tax projection, the status of the business, and more.