Ever wondered how exactly finance teams keep track of every dollar flowing in and out of a business? The secret lies in the accounting cycle, the structured process for financial accuracy and transparency.
Financial Planning & Analysis (FP&A) teams rely on accurate reports that help organizations ensure compliance and make data-backed decisions.
The steps in this accounting process – from recognizing revenue to reconciling expenses or closing the books – each play an influential part in a company’s financial health.
Unlike traditional bookkeeping, FP&A teams leverage the accounting cycle to analyze financial performance and help the company to take action based on the data.
The accounting cycle typically consists of 8–10 steps, beginning with transaction documentation and ending with closing the books for the next period. The details can vary a bit from business to business, but the general process covers most of the same steps.
Let’s break down the steps one by one.
Why is the Accounting Cycle Important?
1. Complying with Financial Regulations
Staying on top of financial records keeps a business in line with tax laws, regulatory requirements, and industry expectations. Investors and auditors trust well-organized records when reviewing a company’s performance.
Reporting errors can result in fines or damage stakeholder confidence. Proper documentation also strengthens loan applications and financial reporting.
2. Better Business Decision-Making
Good financial data is the cornerstone for sound decision-making. A well-structured accounting cycle ensures accurate reports, giving business owners the information they need to assess cash flow, profitability, and future investments.
Without a dependable system, numbers can be inaccurate. With these inaccuracies often comes lost revenue, neglected expenses, or misallocated resources. Clear, precise records make forecasting, budgeting, and operational planning much more manageable.
3. Efficiency and Precision
Keeping financial records in order reduces errors and helps everything function smoothly. Each step in the accounting cycle builds on the previous one, ensuring transactions are accurately documented, and nothing is lost or miscalculated.
When businesses use a strategic approach, financial statements are accurate, deadlines are fulfilled, and decision-makers have the data they need to drive the company on the proper path.
The 8 Steps in the Accounting Cycle
Each accounting period (typically a month, quarter, or year) follows a pre-determined process. Adhering to this process helps finance teams record and report financial data properly.
Here’s a breakdown of the eight can’t-miss steps in the accounting cycle:
1. Identify and Analyze Transactions
The cycle kicks off by tracking every financial move a business makes. This means collecting receipts, invoices, bank statements, and contracts to figure out what needs to be recorded.
For instance, if a retail store buys inventory on credit, the records need to show how much is owed to the suppliers.
Likewise, if a consultant gets paid in advance for a project, that payment isn’t counted as revenue until the work is done.
Loans, expenses, and customer payments all need to be recorded correctly to keep financial reports accurate.
2. Record Journal Entries
Once transactions are identified, they are recorded in a journal as debit and credit entries following the double-entry accounting system.
Let’s say a company purchases $2,000 worth of office supplies on credit.
In this case, the journal entry would look like this:
- Debit: Office Supplies ($2,000)
- Credit: Accounts Payable ($2,000)
This keeps assets and liabilities balanced. Businesses also need to make sure journal entries include proper documentation and explanations to streamline audits and financial reviews.
3. Post to the General Ledger
Next, journal entries go to the general ledger. This is where transactions are categorized into accounts (e.g., revenue, expenses, liabilities).
This numbered account list includes your business’s different account types to categorize transactions.
These vary from business to business but often include line items like:
- Accounts Payable
- Cost of Goods Sold (COGS)
- Cash Account
- Professional Services Expense
- Receivables
- Revenue
The ledger also helps businesses spot trends or red flags. Examples might include recurring expenses or changes in revenue patterns.
4. Prepare an Unadjusted Trial Balance
The trial balance is a preliminary list of all ledger accounts and their balances at the end of the accounting period. It checks whether debits equal credits and identifies posting errors before moving to financial statements.
If the trial balance doesn’t balance the company is required to investigate a few different things to problem solve, including:
- Missing entries
- Duplicated transactions
- Misclassified accounts
Note: The more manual entries that a company relies on (especially in Excel), the more room there is for mistakes. That’s one of the reasons why accounting and FP&A automation software such as Datarails is important – it reduces manual errors and frees up more time for analysis.
Importantly, a balanced trial balance does not guarantee accuracy, but it does confirm that the accounting equation (Assets = Liabilities + Equity) is correctly followed.
5. Adjust Journal Entries
Since financial transactions often span multiple periods, entries need adjusting for accruals and deferrals.
Here are a few examples:
- Accrued Expenses: These are expenses that are recorded on the books but not yet paid. Employee salaries that haven’t been paid yet are one example.
- Depreciation: Allocating the cost of long-term assets over time such as company machinery.
- Prepaid Expenses: Adjusting expenses paid in advance, like insurance, to reflect usage.
- Revenue Recognition: Recognizing income only when earned, not when received in advance.
Adjusting entries ensures financial statements accurately represent a company’s financial status for the stated period.
6. Prepare an Adjusted Trial Balance
Once you’re done making adjustments, you’ll prepare a second trial balance to verify that all entries are accurate.
Any discrepancies at this stage need to be fixed right away before you move on to generating financial statements.
7. Prepare Financial Statements
Financial statements are the culmination of the accounting cycle. These statements provide a thorough view of a company’s financial performance and status.
Business owners, investors, and other stakeholders all rely on these statements to understand profitability, assess financial stability, and make sound decisions.
The adjusted trial balance generates three main financial reports:
- Income Statement: This report details a company’s revenues and expenses over a specific period, ultimately showing whether the business profited or lost money. An income statement provides insight into operational efficiency and financial performance trends.
- Balance Sheet: This is the snapshot of a company’s financial standing at a given moment, listing its assets, liabilities, and owner’s equity. The balance sheet helps businesses understand their financial health, liquidity, and long-term sustainability.
- Cash Flow Statement: This report tracks how cash flows in and out of the business through operations, investments, and financing activities. It highlights a company’s ability to generate cash, cover expenses, and fund growth initiatives.
8. Close the Books
At the end of the period, it’s time to close the books. This means businesses reset revenue and expense accounts by transferring balances to retained earnings. This prepares the accounts for the next accounting cycle.
Businesses might include other steps, including:
- Post-Closing Trial Balance: Ensures all accounts balance after closing entries.
- Reversing Entries: Simplifies recording accruals in the next period.
Automation in the Accounting Cycle
Businesses handle financial data differently in the age of automation—traditional accounting processes require extensive manual work.
This not only makes them more time-consuming and error-prone, but it also keeps your staff occupied with tasks that could be done more efficiently with automation.
Those team members could better spend their time on other tasks that can not yet be automated.
Fortunately, modern accounting software can automate many tasks, improving efficiency and accuracy.
In FP&A, three primary benefits of automation are that it helps streamline:
- Data entry
- Transaction recording
- Financial reporting
In turn, accountants can focus on strategic analysis rather than manual bookkeeping. Businesses increasingly turn to cloud-based accounting systems to facilitate real-time collaboration, automated reconciliations, and compliance tracking.
With technological advancements, Datarails provides Financial Planning & Analysis software that automates many accounting processes.
These tools help integrate with payroll, invoicing, tax preparation, financial reporting, and compliance reporting functions, reducing the time spent on manual entries and improving accuracy across financial operations.
Other Uses for Automation in the Accounting Cycle
Automation is often credited with speeding up the accounting process but also substantially expands financial management capabilities.
For example, businesses can utilize advanced analytics, automated forecasting, and real-time compliance monitoring. These features help them make better decisions (in less time) and reduce the risk of human error.
Automation is designed to continuously update financial records to catch and eliminate discrepancies between accounts. This reduces the workload on finance teams.
- AI and Machine Learning: Some software platforms now use AI to detect anomalies, suggest adjustments, and improve forecasting. Learn about Datarails AI-powered FP&A chat next.
- Seamless Real-Time Updates: Automation ensures financial records stay current, helping teams act quickly with the most up-to-date information.
- Integration with Banking and Payment Systems: Many accounting tools now integrate with business bank accounts and payment processors, automatically categorizing transactions and reconciling statements.
To learn more about Datarails or watch its automation capabilities in action, request a demo today.
