How to Design an Accounting Cycle for Your Business?
Effective financial management, through vigilant monitoring of business finances and sound bookkeeping practices, is essential for maximizing enterprise growth. Financial statements are pivotal in assessing a business's overall financial health, aiding in strategy, investor attraction, issue anticipation, and tax compliance. The accounting cycle, comprising eight standardized steps, transforms raw financial data into usable statements, akin to a chart of accounts. Mooncard offers a concise guide to the crucial accounting cycle in this article, explaining its significance, implementation, and role in managing a business's financial well-being.
The accounting cycle – a quick definition
The accounting cycle is a term used to describe the bookkeeping method of recording, processing and analysing all aspects of a business’s financial activities. This involves following a standard process of eight steps. The accounting cycle begins whenever a transaction occurs and finishes with the inclusion of all transactions in the business’s financial statements. Usually, a bookkeeper is responsible for managing the accounting cycle.
The time period that a particular accounting cycle may cover depends on the nature of the business and its individual bookkeeping requirements. Each business has its own reporting systems and tax obligations, so the length of every accounting cycle is different. Some businesses may wish to evaluate their performance each month, others may require quarterly financial statements to aid with tax reporting and yet others may prefer to maintain an annual accounting cycle. Regardless of the length of time chosen, once an accounting cycle has been completed, another new cycle starts, and the eight steps are resumed from the start to the finish once again.
Often, a business will use accounting software that automates the entire process of the accounting cycle. In some cases, however, a bookkeeper may need to manage the accounting cycle to ensure accuracy. On the whole, automating part or all of the accounting cycle can result in fewer errors and saves a great deal of time.
The steps involved in the accounting cycle can be customised to meet individual business requirements and accounting procedures. Some businesses, for instance, use single-entry accounting, while others may choose to use double-entry accounting. Double-entry accounting is commonly used to create the three main financial statements, which are:
- The income statement
- The balance statement
- The cash flow statement
Why an accounting cycle is important for your business
The aim of the accounting cycle is to make it easier for business owners to account for all the financial transactions completed by an enterprise. The accounting cycle helps bookkeepers maintain precise and well-organised records and prepare accurate financial statements.
These statements then provide a detailed overview of the financial health of a business. The information contained in the statements can be used to develop marketing strategies, create plans for growth, attract investors and prepare for any shortfalls. Financial statements prepared using the accounting cycle also collect crucial information required by His Majesty’s Revenue and Customs (HMRC).
The eight steps of the accounting cycle
While the exact steps in an accounting cycle may differ depending on the type of accounting system used by the business in question, in general, there are eight steps to follow. The most commonly used eight steps in an accounting cycle are:
- Identify transactions
- Journal entries
- General ledger
- Trial balance
- Adjust journal entries
- Financial statements
- Ensure accuracy
- Closing entries
We’ll now take a closer look at each one of these eight steps.
Step one: Identify transactions
The very first step in the accounting cycle is to identify all transactions made by the business. These comprise any type of transaction that could be designated as a bookkeeping event, such as a sale, a refund, the purchase of an asset or any business expense that has been incurred.
Step two: Journal entries
Once all transactions that are relevant to the business have been identified, they need to be recorded as journal entries into a ledger or an accounting software program. Journal entries must be entered in chronological order and take into account all credits and debits. The double-entry accounting method notes that when a particular account is debited, another must be credited to ensure that all accounts balance. Single-entry accounting provides a simple overall balance report.
Step three: General ledger
The next step is to take all the collated information and enter it into a general ledger or chart of accounts that lists all the financial activities undertaken by the business under different account categories and sub-categories. Many businesses use accounting software that automates this process.
Step four: Trial balance
After all data has been entered into the general ledger, an unadjusted trial balance is calculated. This balance corresponds to the time period of the accounting cycle, whether that is monthly, quarterly or annually. The unadjusted trial balance should ensure that the total amount of recorded debits match the total amount of recorded credits. If the number of credits and debits do not match, then a bookkeeper must create a worksheet and try to adjust the figures to correct any discrepancies.
Step five: Adjust journal entries
At the end of the accounting cycle, the bookkeeper must post adjusting entries that show any corrections made on the worksheet and detail any changes that have been due to the passage of time. For instance, interest on business savings may have accrued or an asset may have depreciated.
Step six: Ensure accuracy
The data must then be gone over thoroughly by the bookkeeper to ensure it is accurate and that all the recorded figures balance. Modern accounting software is highly proficient in detecting mistakes and can notify bookkeepers whenever a correction must be made.
Step seven: Financial statements
With the data now accurate, it can be compiled into the three main financial statements: the balance sheet, the income statement and the cash flow statement. These statements can then be distributed to all stakeholders connected to the business, whether they be upper management, shareholders, investors and so on. In some cases, financial statements may need to be provided to government authorities such as HMRC or to financial institutions.
Step eight: Closing entries
The last step in the accounting cycle is to transfer all information into a permanent record and close and zero out the expense and revenue accounts for the accounting cycle period. Closing entries are calculated to prepare a post-closing trial balance to ensure that all credits and debits balance. If so, then the books can be closed, and a new accounting cycle can begin.
What you can do to improve your business accounting
Following the accounting cycle steps will help to ensure that your business keeps accurate records and has sound data on which to base decisions. Keeping a focus on maintaining consistent records and developing business-wide accounting procedures will improve your business accounting.
Mooncard makes it simple for businesses of all sizes to track expenditures. With a Mooncard payment card system, every time a business purchase is made, an employee takes a digital photo of the invoice or receipt. This data is then automatically collated into an expense report which is then sent straight to the accounting department. Bookkeepers can incorporate this data into the accounting cycle process to create accurate and precise financial statements. To discover just how Mooncard can help your company streamline its accounting procedures, you can book a free, no-obligation online demonstration via our website.
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