What Is the Accounting Cycle?

What is the accounting cycle?

The accounting cycle is a comprehensive process designed to make a company’s financial responsibilities easier for its owner, accountant or bookkeeper to manage. The accounting cycle breaks down financial management responsibilities into eight essential steps to identify, analyze and record financial information. It serves as a clear guideline for completing bookkeeping tasks accurately. 

The accounting cycle is a holistic process that records a business’s transactions from start to finish, helping companies stay organized and efficient. The cycle incorporates all the organization’s accounts, including T-accounts, credits, debits, journal entries, financial statements and book closing. 

One of the accounting cycle’s main objectives is to ensure all the finances during the accounting period are recorded and reflected in the statements accurately. It’s like a checklist to complete when an accounting period ends. 

A business can conduct the accounting cycle monthly, quarterly or annually, depending on how often the company needs financial reports. They can then use the data to assess the company’s financial health.

Accounting cycle time period

A business’s accounting period depends on several factors, including its specific reporting requirements and deadlines. Many companies like to analyze their financial performance every month while others focus on quarterly or annual reports. 

At the end of the accounting period, companies must prepare financial statements. Public entities need to comply with regulations and submit financial statements before specified deadlines. 

Modifying the accounting cycle

Companies can modify the accounting cycle’s steps to fit their business models and accounting procedures. One of the major modifications you can make is the type of accounting method used. Organizations may follow cash accounting or accrual accounting or choose between single-entry and double-entry accounting. 

Double-entry accounting is ideal for businesses that create all the major accounting reports, including the balance sheet, cash flow statement and income statement.

The accounting cycle’s 8 steps

Here’s an in-depth look at the eight steps in the accounting cycle. Once you check off all the steps, you can move to the next accounting period. 

1. Identify and analyze transactions during the accounting period.

A business starts its accounting cycle by identifying and gathering details about the transactions made during the accounting period. When identifying a transaction, you’ll need to determine its impact. Transactions include expenses, asset acquisition, borrowing, debt payments, debts acquired and sales revenues. 

2. Record transactions in a journal.

The next step is to record your financial transactions as journal entries in your accounting software or ledger. Some companies use point-of-sale (POS) technology linked with their accounting books, combining steps one and two — sales data from the POS system will transfer into your accounting solution’s financial records automatically. Still, businesses need to fill out expense reports to track monies paid.

Your accounting type and method determine when you identify expenses and income. For accrual accounting, you’ll identify financial transactions when they are incurred. Meanwhile, cash accounting involves looking for transactions whenever cash changes hands. 

Double-entry accounting suggests recording every transaction as a credit or debit in separate journals to maintain a proper balance sheet, cash flow statement and income statement. Meanwhile, single-entry accounting is more like managing a checkbook. It doesn’t require multiple entries but instead gives a balance report.

3. Post transactions to the general ledger.

Once transactions are recorded in journals, they are also posted to the general ledger.  A general ledger is a critical aspect of accounting as it serves as a master record of all financial transactions.

The general ledger breaks down the financial activities of different accounts so that you can keep track of various company account finances. A cash account is by far the most crucial account in a general ledger as it gives an idea of the cash available at any time. 

4. Calculate an unadjusted trial balance.

While the preceding accounting cycle steps happen during the accounting period, you’ll calculate the unadjusted trial balance after the period ends and you’ve identified, recorded and posted all transactions. The trial balance gives you an idea of each account’s unadjusted balance. Such balances are then carried forward to the next step for testing and analysis.

Creating an unadjusted trial balance is vital for a business as it helps ensure that total debits equal total credits in your financial records. If they don’t, something is either missing or misaligned. This step generally identifies anomalies, such as payments you may have thought were collected and invoices you thought were cleared but weren’t. 

Regardless of the scenario, an unadjusted trial balance displays all your credits and debits in a table. In the next step, you’ll investigate what went wrong. 

5. Analyze the worksheet to identify errors.

The accounting cycle’s fifth step involves analyzing your worksheets to identify entries that need to be adjusted. As every transaction is recorded as a credit or debit, this step requires ensuring that the total credit balance and debit balance are equal. [Related article: Direct Costs vs. Indirect Costs]

Apart from identifying errors, this step helps match revenue and expenses when accrual accounting is used. Any discrepancies should be addressed by making adjustments, which happens in the next step. 

6. Adjust journal entries to fix errors.

When the accounting period ends, you’ll adjust journal entries to fix any mistakes and anomalies found during the worksheet analysis. Since this is the final step before creating financial statements, you should double-check everything with the help of a new adjusted trial balance.

7. Create and produce financial statements.

Once the company has adjusted all the entries as necessary, you can create financial statements. Most businesses generate balance sheets, income statements and cash flow statements. 

The balance sheet and income statement depict business events over the last accounting cycle. A cash flow statement, while not mandatory, helps project and track your business’s cash flow.

These financial statements are the most significant outcome of the accounting cycle and are crucial for anybody interested in comparing your business’s performance with others. They are also highly valuable for business owners. Interpreting financial statements helps you stay on top of your company’s finances and devise growth strategies. 

8. Close the books for the accounting period.

The last step in the accounting cycle is to make closing entries by finalizing expenses, revenues and temporary accounts at the end of the accounting period. This involves closing out temporary accounts, such as expenses and revenue and transferring the net income to permanent accounts like retained earnings. 

After you close the books, the financial statements produced provide a comprehensive performance analysis for the time frame. Then the accounting cycle starts again for the new reporting period. 

This is a good time to file paperwork and plan for the next accounting period. 

Accounting cycle vs. the budget cycle

The accounting cycle is not the same as the budget cycle. While an accounting cycle focuses on events during a specific period and makes sure financial transactions are reported accurately, a budget cycle is associated with future performance and helps plan future transactions. 

The accounting cycle helps produce helpful information for external users, such as stakeholders and investors, while the budget cycle is used specifically for internal management. 

Best accounting software for automating the accounting cycle

Accounting software helps automate several steps in the accounting cycle. Depending on the solution, bookkeepers, certified public accountants and business owners don’t have to intervene or perform some accounting cycle tasks manually. Instead, they can set up workflows in their program of choice to complete various parts of the process. Another perk of using accounting software is the reporting functionality that allows you to generate essential reports and analyze your company’s financial health easily.

Below are our choices for some of the best accounting software products to simplify the accounting process and manage your organization’s finances better:

• Intuit QuickBooks Online: This respected brand stands out for producing high-quality software with accounting capabilities that are tailored for small businesses. QuickBooks Online simplifies financial management tasks, including invoicing, expense tracking and profitability analysis. Its automated workflows allow you to track your income easily while sorting expenses into specific categories. To learn more about this program’s robust tracking and organizing features, check out our detailed QuickBooks Online review.
• Wave Financial: This software is an excellent choice if you’re seeking an affordable but reliable accounting software solution. The Wave platform is free yet it offers a wide range of features that make financial management effortless. For example, you can create accurate financial reports with a few clicks and the user-friendly interface and straightforward manual transaction entry make it easy to track income and expenses. Read more about how this software can streamline and improve your accounting process in our full Wave Financial review.
• Oracle NetSuite: If you’re looking for advanced accounting features, Oracle NetSuite might be your preferred option. This cloud-based financial management solution allows you to track financial data and create custom income statements effortlessly to suit your specific needs. This platform also supports various business setups, including transactional and subscription-based models, to give you the most accurate reporting. Learn more about this software and its full suite of reporting and planning tools in our Oracle NetSuite review.
• FreshBooks: Like some of our other top vendors, FreshBooks provides business owners extensive flexibility by offering multiple plans with varying features. While your needs and budget should dictate which package you choose, you can also customize your FreshBooks setup by opting for one of the available add-ons, such as payroll processing. This helps ensure your accounting and payroll records are fully integrated. Our comprehensive review of FreshBooks breaks down the different plans and features.
• Xero: We especially like Xero for its invoicing and billing tools. This accounting software allows you to not only create invoices and accept client payments but also pay your company’s own bills and track expenses. As your credits and debits change, you can rest assured the program’s double-entry accounting is accurately recording all transactions. With this data, you can analyze profitability and cash flow forecasts. Even better, the “report package” tool combines balance sheets, profit and loss statements and other key reports into a single document for convenient reference. Find out about costs and more in our in-depth review of Xero.

Using financial insights to maximize your business potential

There are many essential parts of your business’s operations and keeping accurate financial records is fundamental among them. The accounting cycle doesn’t need to be complicated. Let accounting software work behind the scenes to perform critical tasks. You can then use your time and resources to make strategic decisions with the information you’ve gathered from these key reports. Ultimately, understanding and executing the accounting cycle properly empowers you to steer your business toward greater financial stability.

Shayna Waltower contributed to this article.