Starting your journey of understanding the accounting world can feel like stepping into a complex maze of numbers, ledgers, and financial reports. Fear not! The accounting cycle is the roadmap that simplifies the journey, providing structure and clarity to the back end of your business. In this beginner’s guide, we’ll unravel the accounting cycle, step by step, and equip you with the knowledge needed to navigate the financial world with confidence.
What is the Accounting Cycle?
The accounting cycle is a series of steps that businesses follow to record, organize, and report financial transactions. This process helps maintain accurate financial records, ensure compliance with regulations, and make informed business decisions.
Step 1: Identifying Transactions
The cycle begins with identifying and documenting all financial transactions that occur within the business. This includes sales, purchases, expenses, and any other monetary activities. This can be done on daily, weekly, or monthly.
Step 2: Journalizing
Once transactions are identified, they are recorded in a journal. The journal is like a diary that chronicles each transaction, including the date, description, accounts involved, and monetary value.
If you are using Quickbooks Online, this step is completed when transactions are pulled into the banking screen.
Don’t forget to reconcile all balance sheet accounts! I have an easy to follow guide here for reconciling!
Step 3: Posting to the General Ledger
The general ledger is a central hub where all transactions recorded in the journal are categorized into specific accounts. Each account represents a financial element such as assets, liabilities, equity, income, and expenses.
If you are struggling with understanding the accounting equation (assets = liability + equity) here is an article to reference!
If you are using Quickbooks Online, this is when you ACCEPT the transaction in the banking screen.
Step 4: Preparing the Trial Balance
With transactions posted, a trial balance is compiled. This is a summary of all the debit and credit balances in the general ledger. The trial balance ensures that the books are in balance, meaning the total debits equal the total credits.
This is how the accountants make sure transactions are recorded correctly. With the rise of automated technology, this step has become somewhat obsolete and the report can be generated with a click of a button!
Step 5: Adjusting Entries
To reflect accrual accounting and ensure accuracy, adjusting entries are made. These entries address items such as prepaid expenses, accrued income, and depreciation. Adjusting entries ensure that financial statements accurately represent the business’s financial position.
Most small businesses use CASH basis accounting, meaning income and expenses are only realized once collected.
Tax preparers will share year end adjusting entries once returns are complete and can be entered manually.
Step 6: Preparing Financial Statements
Now comes the creation of the financial statements: the balance sheet, income statement, and cash flow statement. These documents provide a snapshot of the business’s financial health, detailing assets, liabilities, equity, income, and expenses.
Reports can quickly and easily be generated in Quickbooks Online with the push of a button! Reports are to be reviewed by management prior to any