What is the accounting cycle?

The accounting cycle is a standard, 8-step process that tracks, records, and analyzes all financial activity and transactions within a business. It starts when a transaction is made and ends when financial statements are issued and the books are closed.

Full-cycle accounting offers a reliable method for developing comprehensive and accurate financial statements at the end of an accounting period, while also supporting business planning and legal compliance.

Why is the accounting cycle important?

The purpose of the accounting cycle is to accurately capture all sales, purchases, and transactions to get a full picture of an organization’s financial health. Accounting cycle information can be used to track all financial transactions that occur at an organization during its accounting period. The process protects companies from costs and risks associated with unpaid expenses, accounting errors, and unaccounted-for funds.

The cycle verifies that everything in the general ledger is correct by recording, classifying, and auditing all business transactions. By doing this, it confirms that a business has an accurate picture of its financial standing. When full-cycle accounting is carried out effectively, it leaves little-to-no room for error, missing funds, or fraud. It gives stakeholders a clear view into operational performance, enabling more informed strategic financial planning. 

Accounting cycle vs operating cycle

While the accounting cycle is used to record transactions from beginning to end and generate financial statements, the operating cycle pertains to how businesses obtain and sell inventory to customers. Typically, the operating cycle aligns to the number of days it takes to receive or create inventory, sell it, and receive payment.

The accounting cycle and the operating cycle are independent from one another and often differ in length. However, because the operating cycle is essential for cash flow management, businesses must track both. 

While the operating cycle offers important insights, the accounting cycle generates a much more comprehensive picture of the company’s value because it evaluates all revenues and expenses.

Accounting cycle vs budget cycle

A budget cycle is used to plan for future transactions, while the accounting cycle ensures that all of a company’s past financial transactions are reported correctly. Though an accounting cycle can repeat monthly, quarterly, or yearly depending on the organization, budgets are generally prepared on an annual basis.

Budget cycles are also internal processes that help manage operations, while the financial statements generated from accounting cycles are used for both internal and external purposes. By offering a clear picture into a company’s financial value, internal financial statements can help decision makers budget more effectively in the future. External financial statements, by contrast, are provided to external decision makers and compliance overseers (e.g. investors, government agencies, and creditors). They may be required by law or used to acquire funding.  

Related read: Key trends shaping the accounting profession in 2024   

What is the bookkeeping cycle?

While the accounting cycle is sometimes referred to as the bookkeeping cycle, bookkeeping and accounting are far from the same. Bookkeeping encompasses the daily tracking of a business’ financial transactions. Along with budgeting and accounting, bookkeeping is an essential administrative practice that ultimately gives businesses a clear picture of their financial standing. 

Companies should maintain strong bookkeeping practices to ensure accountants have the information  necessary to prepare broad assessments and financial statements through the 8-step accounting cycle. The result? More efficient and streamlined budgeting processes.

8 steps in the accounting cycle 

The eight steps in the standard accounting cycle process help companies record transactions and correct mistakes to prepare accurate financial statements at the end of an accounting period. With modern technology, many aspects of full-cycle accounting are automated to ease as much of the administrative burden as possible.  

Related read: Simple steps to streamline your accounting workflows

1. Identify and record transactions

The first step in the accounting cycle involves recording all the money earned and spent, paid and owed, as soon as expenses are incurred or payment is received. For businesses that are continually making financial transactions such as buying inventory, paying bills, and collecting revenue, this step will be ongoing. Recording transactions accurately during this first step makes sure that the following stages of the process aren’t based on errors, ultimately helping companies to arrive at a fully accurate picture of their finances.   

2. Create journal entries 

The international standard for the second step of the accounting cycle is double-entry accounting. This is when the transactions identified in the first step are given two journal entries.  One entry lists the source of their financial benefit (credit) and the second records the destination of their financial benefit (debit). Modern accounting technology streamlines the process by combining the first two steps of the cycle to automatically generate credit and debit entries.

The timing of this step depends on whether a company uses cash-basis or accrual-basis accounting to track finances. Accrual accounting matches revenues with expenses, so companies using this method must remember to record both together. The accrual-basis accounting method provides a more comprehensive overview of a business’s financial situation and is often a necessary process for large and enterprise companies.

3. Post to the general ledger 

The general ledger is a company’s central database for keeping track of all financial transactions, broken down by account. During this step, every journal entry should be posted to its relevant account in the general ledger. This process is often automated with accounting software.  

In addition to revenue and expense accounts, the general ledger may include accounts for assets, liabilities, gains, losses, and more depending on how a company operates. Each account has a subledger within the general ledger, and transactions are recorded to each based on the nature of their financial activity.  

4. Pull an unadjusted trial balance report 

At the end of the accounting period, accountants total up the credit and debit balances for their company. This is called an unadjusted trial balance. It isn’t a final report — it’s only calculated at this juncture to help catch mistakes. If the credit and debit balances don’t match, then accountants can be sure that errors occurred at some point during the first three steps. They will find and correct these during the next steps of the accounting cycle. 

5. Analyze worksheets 

Once the trial balance turns up a discrepancy between the credit and debit balances, accountants must line up debits and credits in a single worksheet to figure out what errors or anomalies are creating the mismatch. This analysis, for example, could lead to the discovery of a debit entry for a purchase of a $100 inventory item that is also recorded as a $50 credit. Because debit and credit entries should be equal, it’s clear that an error has occurred. From here, the accountant must figure out what adjustments to the general ledger are needed to get an accurate picture of the company’s finances. 

6. Make adjusting journal entries

After all errors are found and solutions are identified, accountants need to make adjusting journal entries and post them to the general ledger. Once complete, the balance recorded in the company’s books is considered correct. 

7. Generate financial statements 

Next, accountants will generate financial statements using the adjusted balances in the general ledger. For most companies, financial statements will take the form of an income sheet, cash flow statement, and a balance sheet — reports that summarize the company’s financial activities over a period of time and provide a clear picture of their financial position. Businesses must ensure these important documents are kept well organized and secure at all times to protect against costly data breaches.

8. Close the books

Closing the books resets temporary accounts — including revenue and expenses — back to zero so that they don’t carry over to the next accounting period. Net income or loss is transferred to a permanent account that records retained earnings. Closing statements that analyze a company’s financial performance may be issued, and accountants prepare for the next accounting period. 

Related read: Select the right technology to elevate your client experience

Master 8 steps in the accounting cycle with tech

The accounting cycle is a thorough, time-consuming process, but it gives companies the power to understand their financial activities with as much accuracy as possible. Technology can greatly improve full-cycle accounting workflows while upholding the strong security protocols necessary for protecting sensitive financial documents. 

Move through these eight steps with ease by choosing accounting technology  built to help you manage and safeguard important documents every step of the way.