What is an accounting cycle?
An accounting cycle is a complete and holistic process of identifying, recording, and calculating various financial events in the accounting portion of an organization. It incorporates accounts, journal entries, debits, credits, and other transactions leading up to a financial statement. In many instances, the full cycle comprises a one-year accounting period.
An accounting cycle is a standard process designed to structure accounting processes for business owners. Companies turn to accounting software to automate the financial management process while ensuring accurate records and increasing efficiency.
Steps in an accounting cycle
There are eight steps in an accounting cycle. The order of the steps and how they are described may vary depending on the business; however, the overall process should remain consistent for the best results. Below are the eight steps:
- Identify all business transactions. Kick off the accounting cycle by identifying business transactions first. Transactions consist of events directly related to the organization’s financial activities. Some examples include expenses, purchases, and revenue.
- Record transactions accordingly. After transactions are identified, they need to be properly recorded. Transactions are recorded using journal entries and should be organized chronologically, beginning with the first transaction at the start of the fiscal year.
- Post to the general ledger. Once transactions are recorded as journal entries, the next step is to post them to an account in the general ledger. The ledger summarizes the company’s accounts, and transactions are posted to their respective accounts.
- Calculate the trial balance. Depending on the business, an accounting period can be a month, a quarter, or a year long. The trial balance should be calculated at the end of an organization’s preferred accounting period. This calculation is used to ensure credit and debit entries are equal. The totals should be the same when the credit and debit balances are added together.
- Adjust entries as needed. At the end of the accounting period, entries also need to be adjusted to account for accruals and deferrals.
- Update the trial balance. If the trial balance calculations didn’t match up, entries may need to be adjusted. Remember the credit and debit totals should be equal. If they aren’t, use a worksheet to keep track of entry adjustments that are made to adjust the balance.
- Prepare financial statements. Upon posting adjusted entries, up-to-date accounts should be used to prepare formalized financial statements. These financial statements include income, cash flow, and balance sheets.
- Close the books. The final step in the cycle consists of closing the business’ books or concluding financial activity for the accounting period. At this point, revenue and expense accounts are zeroed out and a new accounting period begins.
Benefits of accounting cycles
While the holistic accounting cycle might seem like a long and complicated process, it’s a worthwhile process worth implementing. The accounting cycle is the foundation for an organization’s accounting process and there are many benefits, including:
- Accurate financial reporting: Keeping financial records throughout the accounting cycle is beneficial for generating a business’ financial reports. Financial reports are crucial for understanding an organization’s performance and profitability insights. The accounting cycle promotes clean and accurate records for valuable reports.
- Compliance: The recordkeeping associated with the accounting cycle supports compliant practices, ensuring businesses are following government regulations and tax requirements. Companies need to have an accurate picture of their finances to pay taxes properly.
- Streamlined processes: Following an accounting cycle gives team members a roadmap to follow. By having a general structure in place, teams can create strategies and implement tools that support them every step of the cycle. This helps streamline processes and creates efficiencies.
Accounting cycle best practices
Some general best practices should be kept in mind throughout the accounting cycle. Consider the following to achieve the best results:
- Set timelines and deadlines along the way. No matter the duration of a business’ preferred accounting period, consider setting timelines and deadlines for the team. Map out a plan in advance, so everyone knows what to expect throughout the process.
- Modify the cycle as needed. Even though the overall accounting cycle is a standard process, it’s not a one-size-fits-all solution. Companies should tweak each step in the cycle as needed to accommodate the business’ accounting flows and schedules.
- Implement software tools. Automating various components of the accounting process can be a timesaver. Use software to implement parts of the process to save time and effort.
Accounting cycle vs. budget cycle
While accounting and budget cycles are both used in finance, there are some significant differences between the two.
An accounting cycle is used for financial events that occurred in the past. On the other hand, a budget cycle involves preparing and approving a budget for future financial events that haven’t happened yet using budgeting and forecasting software.
Alyssa Towns
Alyssa Towns works in communications and change management and is a freelance writer for G2. She mainly writes SaaS, productivity, and career-adjacent content. In her spare time, Alyssa is either enjoying a new restaurant with her husband, playing with her Bengal cats Yeti and Yowie, adventuring outdoors, or reading a book from her TBR list.
