The kind of clean compliance, swift productivity, efficient costs and accurate data delivery that top tier companies expect to unlock massive growth used to only be possible by hiring teams of dozens of bookkeepers and accountants - making starting and scaling a new company successfully incredibly risky and challenging.
For businesses to be able to analyze their performance, it is necessary that they verify that their financials are accurate by completing certain steps. The accounting cycle consists of these steps because businesses complete the same steps after every accounting period is over.
These steps verify that every transaction during the accounting period shows up in the financial statements: the final historical record for the business. It is paramount that business owners make these accurate. Investors and banks refer to the financial statements when they decide to invest or give you a loan.
The accounting cycle is the essential checklist after every accounting period, which allows you to move to the next period with clean books.
Accounting period = a month, a quarter, or a year, depending on the business.
This process came from the old days when accountants did these steps in journals and physical ledgers. Now, many of these steps happen behind the scenes, thanks to technology.
- Transaction identification - Collect all the data on each transaction from the period - your bookkeeper should be doing this throughout the period. When you recognize each transaction depends on if you use accrual accounting or cash accounting.
- Transaction Recording - Classify the transaction as a debit or a credit in your accounting technology. This used to happen in physical books.
- General Ledger Posting -This should happen automatically thanks to your accounting software, but in the old days, you had to move all transactions to this master list.
- Unadjusted Trial Balance Calculation -This is the first step that can only happen after the accounting period is over, once the previous three steps have all been completed during the cycle. This is like proofreading - you make sure the debit balance equals the credit balance. Many people find imbalances in this step from unpaid invoices or expected collections, or if something was misclassified.
- Adjusting Journal Entries -This is simply when you fix any imbalances found by making new journal entries to align debits and credits.
- Adjusted Trial Balance Creation - As noted in the terminology post, an Adjusted Trial Balance shows your adjusting entries, unadjusted amounts, and unadjusted trial balance - the last step before making your financial statements.
- Make Financial Statements -The Financial Statements are the most important document from the accounting cycle, and include the income statement, balance sheet, and the statement of cash flows (which isn’t always necessary, but recommended). These show what happened in your business during the prior accounting cycle. For you as a business owner, these are paramount to read and understand to make strategies for growth. They also help investors compare your business to others.
- Create Closing Entries -This is when you close out temporary accounts and make them into permanent accounts - ie revenue and expenses to retained earnings. Closing entries ready your business for the upcoming accounting period.
The Impact of Technology on the Accounting Cycle
Technology has automated and simplified previously manual steps in this cycle, such as adjusting trial balances and posting to a general ledger. When this process becomes less manual and much faster, business owners can focus on growing their business, and investing their time, energy and resources where it matters most.