Accurate bookkeeping helps businesses run smoothly — and it starts with the accounting cycle.
This cycle covers all the vital steps you need to track transactions, meet industry standards, and spot problems before they happen. While this integral process varies depending on what tools you use for calculations and how you stock inventory, the main ideas stay the same, and knowing what they are can elevate your accounting.
Here’s a guide to all the steps in the accounting cycle and what they do.
What is the accounting cycle?
The accounting cycle is a multistage process that tracks your financial position as thoroughly and accurately as possible. It involves tracking and logging expenses, moving data to a general ledger (G/L), and ensuring the books are error-free before generating finalized reports.
This cycle is a foundational element of business accounting because it offers the documentation necessary for accurate communications. You can properly generate financial reports, share performance updates with stakeholders, and understand overall business health, all while spotting and fixing potential mistakes quickly.
Explaining the accounting cycle: Why is it important?
The accounting cycle keeps track of all financial activities during a specific accounting period — such as a month, quarter, or year — and verifies their accuracy. This means you document every dollar coming into or going out of your business.
A structured cycle makes it easier to avoid mistakes and spot discrepancies when they happen, avoiding miscommunications and incorrect reports. You or your accountant can feel confident knowing which steps come next and how to comply with regulations, leading to less stress when it’s time to file.
What are the steps in the accounting cycle?
There are several variations of the accounting cycle, and most include somewhere between five and 10 steps.
Businesses with relatively simple accounting workflows can sometimes eliminate a few of the baseline steps. But understanding the full accounting cycle helps you recognize which are important and adjust from there.
Here are the 10 steps to start with.
1. Identify transactions
First, track down and identify all business transactions. As part of this process, you should gather:
- Invoices
- Bank statements
- Receipts
Make sure to collect any other information that details relevant transactions, like payroll data. The goal is to gather documentation of every single transaction.
2. Gather data for a journal entry
Next, review each transaction and gather any supplemental data for journal entries. At a minimum, collect each transaction’s date, amount, and category.
Don’t go overboard here — you’ll analyze entries later. The goal is to gather basic details to record and categorize information properly.
3. Record transactions in a journal
Now, it’s time to record each entry in a G/L, which is a comprehensive, numbered account list. It should lay out all of the company’s transactions by category.
Think of each G/L category as a bucket for transactions, organizing and containing them all according to what they are. Some categories to include are:
- Cost of goods sold (COGS)
- Accounts payable
- Receivables
- Cash accounts
- Professional service expenses
Keep entries in chronological order to make them easier to comb through and navigate. It’s also helpful to follow the double-entry accounting method, which means each entry has two components: a debit and a credit.
4. Create a trial balance
Create a trial balance for each category, adding up the totals for both debits and credits. The debits and credits for each category should be equal. If they aren’t, you’ve made an error somewhere in the calculations and need to go back and find it.
5. Make adjustments
At this stage, make necessary adjustments to all entries. There are three types of adjustments to apply: accruals, tax adjustments, and missing transactions.
Accruals refer to revenue or expenses you’ve incurred or earned but haven’t paid or received. For example, if you received an invoice from a supplier but haven’t paid yet, it’s an accrual. The same rule applies if a customer hasn’t paid an invoice.
Tax adjustments include any tax deductions. Typically, you only calculate these adjustments once per year, according to tax season.
Missing transaction adjustments include any transactions you didn’t include in step one. This could be something simple, like a receipt that someone turned in late.
6. Review the adjusted balance
Repeat step four using your adjustments. Add up the new debit and credit categories to make sure they’re equal. If you made the appropriate adjustments, everything should come out even.
7. Generate financial statements
For some smaller businesses, step seven — preparing financial statements — is the final phase in the accounting cycle. Most create the following three types of statements:
- Statement of cash flow
- Income statement
- Balance sheet
The cash flow statement shows when and how cash enters and leaves your business. It also details how depreciation and other non-cash entries affect net income.
The income statement breaks down how much money the company brings in using the expense account and trial balance revenue sections of your G/L. The balance sheet breaks down liabilities, owner’s equity, and assets.
8. Publish closing entries
After generating the final financial statements, record closing entries and prepare for the next accounting cycle. Transfer the balances to permanent accounts to open up your temporary accounts and start fresh.
9. Review your post-closing balance
After closing out temporary accounts, prepare a closing trial balance. Add up the totals of the updated debit and credit columns to make sure they’re balanced.
10. Record reversing entries if necessary
Reversing entries offset any prepayments or accruals that may have occurred between the two accounting cycles. The idea is to have a clean slate when starting the next accounting period.
This step isn’t necessary for all businesses. If there weren’t any prepayments or accruals, you can skip it.
Revolutionize financial control seamlessly with Fishbowl
Improving data visibility is the first step to mastering the accounting cycle. For that, you need Fishbowl — the leading inventory management system for growing businesses.
Fishbowl aligns seamlessly with your accounting processes, empowering your company with unparalleled control, accuracy, and efficiency every step of the way. It offers a superior accounting experience and unifies your financial data with QuickBooks integration for smooth sailing every time.
Schedule a demo today to learn more.