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Accounting Cycle: What Every Small Business Needs to Know

Accounting is never easy for big or small businesses as it takes a lot of time, but it is necessary if you want to have limited problems and paperwork in the long run. As a small business owner, accounting takes much more work, but it helps run your establishment.


Today, we will try to simplify accounting for you by providing an accounting cycle that can help you start right away.


What Is An Accounting Cycle?


Suppose your goal is to ensure that your financial transactions are correctly reported and shown transparently. An accounting cycle, also known as the ‘bookkeeping cycle’ or ‘accounting process, is how you create financial statements.


Your financial statements give you an outline of all your transactions from start to finish.


It is known to be a cycle because it is a repetitive standard for every accounting period that relates directly to the finances of a business per year. An accounting cycle helps you to manage the money that comes in and out of your company. It is a step-by-step procedure done monthly, yearly, or even daily if your business requires financial reports.


Before looking into the details of the accounting cycle, it's essential to understand why it's so crucial to your company.


Why Do We Need An Accounting Cycle?


A small business owner relies on an accounting cycle to create financial accounting methods that would help set budgets. Below are some other reasons why a small business needs an accounting cycle:


  • It makes you abide by the law. An accounting cycle enables your small business to account for finances following federal standards and tax codes. Big and small companies must report their financial performance and pay taxes according to their revenue.

  • It keeps you productive. An accounting cycle provides concepts and effective accounting techniques. An accounting cycle allows you to list options on what you should do and should not do regarding your company’s finances. This is effective for small business owners like you, especially since you should handle many accounting responsibilities every day. An accounting cycle keeps you up-to-date and saves you knowledge financially.

  • It evaluates the internal health of your business. An accounting cycle can analyze your business’s financial performance. This cycle can help you compile and revise trial balances, evaluate, journalize, and publish transactions. As you complete the cycle, you will know how healthy your company's spending is. You can use your data for future purposes and present this to potential investors.

  • It enhances time management. Accounting cycles help small businesses to plan their time within fiscal periods monthly, quarterly, and annually. You can set reasonable goals for every strategy you make in having financial statements produced in the present and near future.


Six Steps In The Accounting Cycle That You Need To Know


An accounting cycle usually has a lot of variations, and people prefer six, eight, and nine steps due to the differences between accrual and cash accounting. However, we recommend this six-step accounting cycle that breaks down the responsibilities of every small business owner.


Step 1: Determine and evaluate your transactions.


This is the first step in your accounting cycle, and you must gather information about all your transactions during your accounting period. Even as a small business, I am sure you have many transactions.


Business documents such as purchases, capital investment, debt, revenues, canceled checks, and other bank statements during your accounting period must be included. This information contains raw financial data to be recorded in your accounting system.


Specifically, put the transaction date, transacted amount, and where you did the marketing. Afterward, analyze and note down the purpose of the marketing. If you had office supplies that you purchased during the accounting period, this is the step where you write all those down.

Step 2: Post your transactions in a journal.


As a small business, try listing your activities in chronological order. Different accounting types and methods help you analyze your expenses and income. Double-entry bookkeeping consists of debits and credits, giving you an organized balance sheet, cash flow, and income statement.


Credit details the source of your money, and debit indicates where it is supposed to go. For instance, if you started purchasing office supplies for your business, your marketing expense account is debited, and your business card is credited. Another example is when a customer buys products from you, your sales revenue is credited, while your customer’s transaction journal will show a debit.


After transacting credits and debits, you can record the data in your ledger or journal. It is wise to record transactions quickly, and you can use accounting software to accomplish the second step.


Step 3: Create a trial balance.


After finishing your entries and placing them on a ledger, it’s time to create a trial balance. A trial balance helps you see whether your debits match your credits. A trial balance combines the debits and credits to guarantee the compensation for the accounting period in question.


This step is critical, especially if you have missed something. It helps you determine the anomalies you forgot to record or clear, and you can see what went wrong to fix it again.


You usually start by adding the total credits and debits in each account and checking if it is equal. If you have seen errors that need fixing, it is time for the next step.


Step 4: Adjust your entries to create a new trial balance.


Once you find errors and your balancing does not match up, it is your task to adjust the entries.


Adjusting entries guarantee that your financial statements only include data relevant to the period you're interested in.


Adjusting entries ensure that your records only include essential data about your accounting period. There are four primary forms of adjustments:


  • Deferrals refer to the money you spend before counting revenue. For example, if you buy ingredients for goods that you want to sell on the market. Deferred expenses will be paid immediately but reported in a later accounting cycle.

  • Accruals refer to your income and expenses you have not paid immediately. For instance, purchasing equipment from a supplier that you still have to pay. With accrual accounting, future payments and expenses must be included in your records.

  • Tax adjustments focus on depreciation and other tax deductions. Property taxes are an excellent example since this is an ongoing expense for rental owners. You can deduct the costs of owning, maintaining, and operating the property.

  • Missing transaction adjustments happen when you overlook transactions and forget to put them on your entries, such as reimbursing your employee's travel fees. If your company is responsible for your employee’s purchases, you must include them here.


After adjusting your entries, you can create a new trial balance with everything you need to consider. This helps you get all the data you need to prepare for the financial statement.


Step 5: Creating your financial statements.


Now that you are almost through with the cycle, it is time for you to create your financial statement. There are usually three financial statements that you need to prepare.


First is your income statement, which involves your revenue and expenses. You will see how much you have gained from your business and develop solutions to make your business perform well in the next accounting period.


A balance sheet is the second document you need to prepare, involving your assets, liabilities, and equity statement. This will tell you if you lack assets or need more to support your company’s finances.


Your cash flow statement is the last financial statement you need to prepare. This document shows how money comes in and where it goes in your business, and it records data of all economic activities that you manage, invests in, and finance.


Step 6: Closing the books at the end of the accounting cycle.

At last! You are now closing the books by providing a report of your company’s financial performance evaluation over the accounting period.


By closing your entries, you can reset the balance of your temporary accounts to zero. Your temporary accounts are the summed amount of the revenue and expenses of your business.


When closing the books, you also have to transfer the balance of the accounting period to the next one. This contains your permanent accounts, including liabilities, assets, and capital.


SUMMARY


The accounting cycle takes a lot of time, effort, and work, but the good thing is you can see all the financial activity happening in your business. You can focus on creating financial strategies to help you budget the money you can spend and develop plans to generate more income for your small business.


PROFIT Bank is more than willing to offer its services to guide you through the step-by-step accounting cycle. We want to help you achieve progressive growth for your small business financially, consistently, and efficiently.