Keeping accurate and detailed accounting for the purpose of financial statements is an important step to having a successful business. Without proper accounting you will not properly know your sales, expenses, be able to pay taxes, get loans, or sell the business. In a business, an accounting cycle is usually defined as a various step process in which raw data is converted into financial statements that tell you the input and output of money from your business. Financial statements include balance sheets, income statements, and cash flow statements. These sorts of statements give potential investors, buyers, and you as an owner a clear picture of the performance of your business.
To go more in-depth, a balance sheet tells you about your business assets, liabilities, and equities. On the other hand, an income statement shows how profitable the business was during a certain period. It shows revenues, expenses, and profits. Finally, a cash flow statement usually shows how much cash enters and leaves the business during a time period. Having defined these important terms, the following paragraphs will help give readers a picture of the fundamental steps for the accounting cycle are.
Step 1: Record Transactions and Analyze Them
The first major and most important step in the accounting cycle is to record all records that occur in your business. This would include keeping proper receipts, invoices, and statements of all your business transactions within a certain time period. It is important to understand that being good at gathering the raw data will make the accounting cycle easier to complete and it will also show a better indication of how your business is doing. Being disciplined to record all transactions as soon as they occur is probably the best advice towards successfully completing Step 1 of the accounting cycle.
Step 2: Transfer Raw Data Into A General Ledger
The next step in the accounting process is to take all the raw data previously kept from Step 1 and organize them through properly recording them on an accounting ledger. A general ledger is a sheet that summarizes all the financials of your business chronologically. Before computers, the general ledger was a large book where the financial data was recorded by hand, nowadays, this is done on a computer oftentimes by using a software that offers a lot of solutions, such as, properly recognizing and categorizing all transactions efficiently, according to various experts. A ledger should include the date, category, transaction description, and the amount for that transaction. Common ledgers include accounts receivable, where all the money that is owed to a business is recorded and is considered an asset. Accounts payable which records all the money that a business owes (i.e. expenses). Inventory ledgers include the sales or purchases that affect your business in terms of physical goods.
Step 3: Prepare Preliminary Trial Balance
After recording all transactions into a ledger and properly categorizing them, the next step would be to prepare an unadjusted trial balance at the end of the accounting timeline. This means a business would need to further organize their ledger by totaling up all their debits and credits and in turn calculate a total balance for their account. A trial balance provides the date, detail, debits, and credits. The date is usually the end of the accounting cycle. Details would include cash, accounts receivable, accounts payable, supplies, revenue, expenses, total capital, and withdrawals made during that particular period.
Step 4: Adjust Entries At The End of the Fiscal Period
The unadjusted trial balance needs to be fixed at the end of the period. To adjust means to make sure that the financial statements only contain information that is applicable within that particular fiscal period. Usually, the four main adjustments are deferrals, accruals, taxes, and missing transactions. Deferrals are usually the money that is spent before seeing any revenue. Deferrals would include things like an advanced payment from a customer before you delivered the goods or buying assets beforehand that will serve a future use. Thus, deferrals remove any transactions that should not belong in the financial statement for that particular period. Accruals have to do with transactional revenues in which you have not recorded at the time on your ledger. This could include expenses that you have not paid for or bills rendered way after you have provided the services. Thus, accruals ensure that future payments or expenses are taken into account when preparing a financial statement. Tax adjustments aid accounting for depreciation and tax deductions. Missing transactions are added to the adjusted entry, they would include things that you have done during that accounting cycle but forgot to enter.
Step 5: Prepare Final Adjusted Trial Balance
Once all journal entries are adjusted, you create the final trial balance which should take into account all the adjusting entries. The purpose of the adjusted trial balance is to basically prove that all your credits and debits balance out.
Step 6: Prepare Official Financial Statements
Finally, it is time to put all the previous correct information together and develop official financial statements that will tell you how the business money travels, where it is held in, how it got there and the major trends in whether you are having a successful period or not. As previously mentioned, the major financial statements include a balance sheet showing assets, liabilities, and equity. An income statement can also be prepared by using information from expenses, revenues, and the trial balance. Finally, a final round of adjustments is made by an accountant to close out all the company accounts for that particular period. It is also important to reset the system and make it ready for the next fiscal cycle.
The above 6 steps fully described the general accounting cycle which is absolutely necessary to produce financial statements that will help owners to properly analyze trends and figure out where their business should be heading next to achieve success. These financial statements are used to get loans, bring investors, and properly pay business taxes, thus the owners need to ensure they are thorough in executing a proper accounting cycle to produce detailed financial statements.