This infographic breaks down the steps of the basic accounting cycle. If you feel like your books are broken or your accounts don’t reflect what’s happening in your business, then understanding the steps in the accounting cycle will help. Whether you handle the accounting yourself or delegate it to an in-house or outsourced accountant, you'll find this diagram useful as you review the financial health of your company at the end of each month.
Watch Eddy use Excel to show you what happens behind the scenes of your QuickBooks Online General Ledger and Trial Balance reports. This video shows you how your accountant closes your books using data like your retained earnings. The same financial information from the trial balance is used to create reports like your income statement which helps you monitor your company’s performance year over year.
The accounting cycle is what keeps your company’s financial statements accurate. And that’s critical because keeping accurate financial statements for your business isn’t an option. Not only is it mandated by the IRS, but it’s also what enables you to make smart business decisions while attracting investors and lenders.
Yet many small business owners don’t understand what the accounting cycle is or how it works. We put together this resource to walk you through the process and provide advice on how to get started.
The accounting cycle is a nine-step process businesses use to compile all of the information needed to prepare important financial statements. It covers everything from analyzing, measuring, and recording transactions to adjusting balances and closing the books.
Financial statements are formal, accurate records of a business’s financial activity. They’re used by investors, lenders, and government organizations to make decisions about credit, investments, and taxes, respectively. They’re also used internally to track financial health and make purchasing and operational decisions.
Want more information on the what and why of these reports? We dive deeper into each of these financial statements in our post titled What are the Four Basic Financial Statements in Accounting?
There are nine steps accountants and bookkeepers take in the accounting cycle to ensure the consistency and accuracy of financial statements. Click on any of these steps to skip to that part of the process, or read them all in order:
Let’s dig into each step in the sections below.
The accounting cycle runs through the process of collecting, recording, and analyzing transactions over and over again, as needed, to prepare those financial statements. If your business prepares financial statements on a quarterly and monthly basis, expect to step through the accounting cycle multiple times a year.
Your team also repeats different parts of the accounting cycle, especially the earlier collecting, analyzing, and recording stages. For example, a small business will record and analyze transactions countless times in a year. They won’t prepare an unadjusted or adjusted trial balance until after all the necessary financial information is in the ledger. This typically happens right before preparing a financial statement (step #7) at the end of the month or quarter.
The accounting cycle is meant to be followed in order. Each step relies on the ones before it; skip a step (or two) and you risk capturing an inaccurate picture of your business’s financial activity. This not only harms your ability to win credit or investments, it cripples your ability to make sound business decisions and forecast sales.
What’s more, financial statements build upon each other every year. So a mistake one year can impact the accuracy of your financial reporting long into the future. Financial reporting mistakes can kill your business. We examine what happens when companies like WikiLawn, Capital Coating, and Activate Your Vision learned the hard way in Avoid These Dangerous Financial Reporting Mistakes.
Ready to get started with the accounting cycle? Here’s how to navigate each of the nine steps.
In this phase, collect all of your company’s transactions for analysis, measurement, and recording. But here's the first common hang-up: what do you have to record?
As a general rule of thumb, a business should minimally record the following:
In short, collect as many transactions as possible that affect your business’s financial position.
This is also known as journalizing. A journal chronologically lists transactions and other events in terms of debits and credits to accounts. Each journal entry consists of four parts:
You don’t need to keep all your transactions and events in one journal. For example, your cash transactions may exist in a journal separate from other financial events, like returned purchases or credit sales. This makes it easier to sort and find the information you need about cash transactions without wading through irrelevant raw data. It’s also easier to get a glimpse of the amount of cash on hand at any given point.
If you still record financial events by hand, you need to consolidate all of your raw data into one master source. The ledger contains all your transactions and events, as well as a chart of accounts that tracks the following:
General ledger accounting uses the double-entry method. This means that transactions are recorded twice, accounting for debits and credits and how they offset each other. All debits fall under the left-hand column, with credits in a second, right-hand column.
By this point, you’ve posted every transaction for the month or quarter in your ledger, and you’re ready to start preparing your financial statement. Now it’s time to measure your unadjusted trial balance.
The unadjusted trial balance tells you the balances for each of your ledger accounts at the end of your reporting period. To prepare your unadjusted trial balance, go through the debits and credits in your ledger and make sure they balance out. An easy way to do this is to make sure the totals in your debit and credit columns match.
They don’t? Uh-oh. Thankfully, that’s what the next step is for.
This is the time to identify any mistakes or overlooked items in your ledger. As you review line-by-line, ask yourself:
These are the most common reasons for mismatches. It’s easy for something to go wrong when manually tracking so many transactions and financial events. Yes, accounting software can automate much of the process and cut down on errors, but it’s not foolproof. That’s why the accounting cycle includes a dedicated stage for investigation and correction. The adjusting entries step ensures that your business transactions accurately reflect the financial position of your business.
What does this look like in your ledger?
To prepare adjusting entries, add a third column to your ledger alongside your credits and debits columns. This is where you add or subtract from your unadjusted trial balance to reflect what’s really happening with your financials.
Follow these core accounting principles when adjusting entries: the revenue recognition principle, the matching principle, and the accrual principle. The accrual principle is especially helpful for deciding whether to count revenue and expenses that won’t be billed until the next period in the current accounting period. According to the accrual principle, it doesn’t matter if the money hasn’t exchanged hands yet. If you’ve given or received products or services during that reporting period, count them.
The adjusted trial balance provides another opportunity to double-check your work and make sure everything is accurate. To prepare this, insert yet another column in your ledger that adds your unadjusted trial balance to your adjusting entries.
Make sure your new total is $0 before moving to the next stage. Having trouble here? Reach out to a reputable accounting agency like Ignite Spot for help balancing your books.
Congratulations, you’ve done all the recording and number crunching needed to prepare accurate financial statements. The steps above get everything in order to complete most financial statements, including the most common ones: the income statement, balance sheet, cash flow statement, and owner’s equity statement.
This is where you get to actually “close your books.” In this stage, you move balances from temporary accounts, like revenues, expenses, and dividends, to permanent accounts, like an income summary.
Temporary accounts are transactions that occurred during your reporting period. They capture a snapshot of your business over the month, quarter, or year you’re reporting on, and they don’t provide the big picture that a permanent account does.
By moving balances from temporary accounts to permanent accounts, you are
It also gets you ready for your post-closing trial balance.
Just like the previous trial balance stages, this step ensures that the debits and credits in your post-closing trial balance match up. The only difference here is that instead of temporary accounts (all the transactions over the last reporting period), this balance consists only of permanent accounts like assets, liabilities, and owners’ equity.
Balanced totals mean your company properly journaled and posted your closing entries. If your post-closing totals don’t match, you’ll start the next reporting period with inaccurate information, making it impossible to report correctly into the future.
There’s a lot to keep in mind when moving through the accounting cycle each time. If you’re new to the process or have complex financials, the accounting cycle can prove intimidating and overwhelming. Thankfully, there are two resources you can use to make it easier on yourself.
These days, there’s accounting software that eliminates the need to write transactions in a journal and manually copy them over to a ledger. Tools like QuickBooks, FreshBooks, and Wave Accounting allow you to categorize and contain all of your financial events in one place. (Read more about the accounting tools we recommend.)
However, while accounting technology takes away some of the more tedious tasks of closing the books, it isn’t a set-and-forget solution. Businesses still have to learn how to install and use the software, update it regularly without error, and review the numbers to make sure everything is logged accurately. Relying on accounting tools makes the latter work-checking stages in the accounting cycle all the more important.
There’s a learning curve in accounting that most business leaders don’t have time to address. Rather than spend a lot of time and money learning the ins and outs of business financials, startup and small-business executives can outsource their accounting needs.
This not only frees up leadership to focus on growing their brands, teams, and products, but it also gives them access to experts experienced in maximizing profits. For example, Ignite Spot doesn’t just do taxes or bookkeeping. We serve as growth mentors, helping businesses double their revenue (twice), cut company spending by 15%, and get visibility to make better business decisions.
The accounting cycle and Ignite Spot are here to make sure you have all the accurate information you need to grow your business.
By following each of the steps in the accounting cycle, you use checkpoints and a proven process to make sure all your financials are in order every reporting period. Ignite Spot can help you navigate this cycle all while providing essential context to bolster your visibility into your business’s financials. What’s more, we provide customized, financially backed advice on growing your team, choosing profitable vendor relationships, moving from $1 million to $10 million in revenue, and setting goals.
Eddy Hood
