The Accounting Cycle Explained: 5 Simple Steps

The accounting cycle is a must-know for all bookkeepers. It divides the entire process of a bookkeeper’s work into multiple steps. Though accounting software can help, small business accountants working on the books with less technical support should still know and use these processes manually. 

While other versions of the accounting cycle cover more detail, in this article, we’ll bring you an overview of the standard process that includes the five main steps needed to ensure the integrity of a company’s accounting process.

What is the accounting cycle?

The accounting cycle is a straightforward process for carrying out a company’s financial activities. It provides step-by-step directions for recording, examining, and analyzing a company’s financial activities.

The accounting cycle duration will vary depending on the reporting requirements. In general, most business owners strive to close their books on a monthly basis. On the other hand, some may prefer completing the accounting cycle on a quarterly or annually basis. 

What is the purpose of the accounting cycle?

The accounting cycle’s primary goal is to ensure that all the money coming into or going out of a business is accounted for and all financial records are accurate. While preparing financial reports, the accountant will examine accounting entries and processes to be aware of the business’s financial position day-by-day. 

Each step in the accounting cycle works as a check and balance along the way, preventing errors and inaccuracies from occurring in the previous step. Thus, the accounting cycle is an indispensable base or stepping stone for creating financial statements.

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What are the five steps of the accounting cycle?

Step 1 – Collect and analyze transactions

The first step of the accounting cycle is to collect documents of your business transactions, like receipts, invoices, bank statements, etc., for the current accounting period. These documents contain raw financial data that will then be entered into your accounting system before being converted into something meaningful.

You need to keep details of every transaction, including the date, amount, and location. Then, you’ll break down (or analyze) the purpose of each transaction. For example, if you received a receipt from Target, you’ll need to clarify if it was office supplies. If you received a gasoline bill, was it for the company vehicle? It’s essential to collect as detailed information as you can. 

Step 2 – Posting transactions to the general ledger

In the next step, you’ll use the general ledger to record all financial information gathered in step one. The ledger is a comprehensive, detailed list showing all your company’s transactions and how they affect each of its individual accounts. 

The ledger includes various journal entries, which chronologically document all of a company’s financial transactions. Journal entries must follow the rules of double-entry accounting. Whenever a transaction occurs, it must be recorded in the journal entries in two sections: a debit (to state what it’s going towards) and a credit (to state where your money is coming from).

After converting all of your business transactions into debits and credits, it’s time to move them into your company’s ledger. Keep in mind that uploading journal entries to the ledger as soon as possible helps ensure that the business’s records are always up to date. 

Step 3 – Preparing an unadjusted trial balance

You’ll prepare an unadjusted trial balance after posting transactions to the general ledger. The unadjusted trial balance gathers all of these totals together and calculates the total credits and debits in each of your business’s accounts. From that, you can determine individual account balances.

Here’s what an unadjusted trial balance looks like: 

The Accounting Cycle
Example of an unadjusted trial balance (Source: Wikiaccounting)

According to the double-entry accounting rules, all of a business’s credits must be equivalent to the total debits. If the sum of the debit balances isn’t equivalent to the sum of the credit balances, it means that either the step of recording or posting journal entries is incorrect. 

If you do bookkeeping with accounting software, this usually indicates that you entered information incorrectly. The process of searching for and fixing these errors is called correcting entries.

Step 4 – Preparing adjusting entries at the end of a period

You’ll prepare adjusting entries after you’ve finished correcting entries. Adjusting entries ensure that your financial statements only include data that is relevant to the time period you’re working on. There are four main types of adjustments, including deferrals, accruals, tax adjustments, and missing transaction adjustments.

Deferrals are revenues and expenses that have been received or paid in advance but have not yet been earned or used. For example, unearned revenue is money received for goods that have yet to be delivered.

Accruals are unpaid income and expenses that have not yet been recorded through a standard accounting transaction. For example, rent paid at the end of the month is an incurred expense, even though a business can occupy the premises at the beginning of the month if the rent is not yet paid.

  • Tax adjustments help you address expenses that lower your tax liabilities like depreciation and other tax deductions. For example, if you have spent a lot of money on new equipment, you may be able to deduct a portion of the cost this year. Once a year, your CPA will most likely guide you through the process.
  • Missing transaction adjustments allow you to account for financial transactions that you may have overlooked when bookkeeping, such as business purchases made on your personal credit card.

Step 5 – Preparing an adjusted trial balance

After posting all of your adjusting entries, it’s time to create an adjusted trial balance. This adjusted trial balance takes all of your adjusting entries into account.

The main purpose of the adjusted trial balance is to prove that all of your ledger’s credits and debits balance after all adjustments. Once you finish this step, you have all the information you need to start preparing your company’s financial statements!

The bottom line

Understanding the accounting cycle helps bookkeepers and small business owners simplify their accounting processes, and makes financial performance analysis more consistent, accurate, and efficient.

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About Shoeboxed

Shoeboxed is a receipt management application that turns your receipts and business documents into a digital format in just one click by taking a picture straight from your smartphone or scanning a pdf. It automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes.

Access your Shoeboxed account from your web browser or smartphone app. Stay audit-ready with Shoeboxed for FREE now!

All You Need to Know About Outsourced Accounting Services

Not every business owner has the time and energy to manage every aspect of a business. It’s understandable if you are not able to handle all of the responsibilities of running a business. In such cases, outsourced services have become a more common solution for small businesses. 

This article will introduce you to outsourced accounting services, one of the most popular types of outsourced services, and help you decide whether your business needs to use outsourced accounting services or not. 

What are outsourced accounting services?

Outsourced accounting services are a third party that provides a full accounting department experience for small businesses. 

An outsourced accounting service handles day-to-day transactions, accounts payable, accounts receivable, financial statements, taxes, payroll, financial reports, and many other accounting tasks like a regular accounting department. 

Most outsourced accounting services provide a wide selection of packages; you can decide whether you also need a bookkeeper or an auditor. To remain competitive in the market, outsourced accounting service providers must constantly enhance their abilities and certifications. You can rest assured that your books are handled well by finance professionals. 

However, keep in mind that even if you hire an experienced and qualified accountant, you’ll still need to be involved in authorizing invoices, making payments, evaluating timesheets, etc.

The benefits of outsourced accounting services

Cost-saving

Hiring an outsourced accounting service is often cheaper and more cost-effective than hiring in-house staff to handle the finance function. 

By outsourcing, you can save your money on costs that hiring an employee would generate, such as paid leaves, health insurance, retirement, vacation, bonuses, and sick days. You just pay for what you require. 

Furthermore, accounting and bookkeeping services are charged on an hourly basis. It means that you can increase or decrease the number of hours without interruption.

Time-saving 

As your company expands, you’ll realize yourself focusing more on the business’s core value rather than handling administrative tasks. 

As a result, using outsourced accounting services allows you to concentrate your attention, energy, and resources on developing a business strategy. This will then help you increase the business revenue and enhance the relationship with your customers. 

Reduced hiring processes

The hiring process requires many resources. For example, it takes time to develop a recruitment policy, interview, and expenses for onboarding and training new employees. This process usually costs your business a significant amount of time and money and distracts you from other important tasks. 

Outsourced accounting services can help you eliminate hiring and training costs as the service providers already did it for you. All you need to do is choose the most appropriate package for your business, sign the contract, and pay for the plan. 

Accounting scaling made simple

Outsourced accounting service providers can expand their services dramatically in order to compete with their competitors. 

In particular, if your bookkeeping and accounting activities require more than an accountant to handle, you can easily demand more staff from the service agent. 

Automation technologies

Most outsourced accounting services have adopted accounting automation technologies to save time. It also reduces human errors and helps business owners eliminate hazards. 

Moreover, automation technologies will lower the likelihood of internal fraud. You’ll have multiple pairs of eyes on your transaction processing and reports, which provides increased internal controls. Having a dedicated team with expertise in accounting best practices will be far more likely to spot an anomaly than one person who’s probably overburdened and overloaded with work.

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When should you consider using outsourced account services?

Outsourced accounting services are most effective when:

  • A small company doesn’t need a full-time accountant, but it demands someone with higher accounting knowledge and skills than a regular office staff or secretary.
  • A business that can’t afford to hire a full-time accountant with the necessary skills.
  • Temporary services are required, such as extra assistance with end-of-year reports or when a full-time worker is on maternity leave, sick leave, etc.

The bottom line

Choosing outsourced accounting services is not just about handling your accounting activities. It also helps you drive profits, improve cash flow, and grow your business in the long term. You can always discuss with the service provider to design a package that suits your business needs and budget, brings you the peace of mind, efficiency, and actionable financial intelligence you need to succeed. 

About Shoeboxed

Shoeboxed is a receipt management application that turns your receipts and business documents into a digital format in just one click by taking a picture straight from your smartphone or scanning a pdf. It automatically extracts, categorizes, and human-verifies important data from your receipts so that you can go over and check your records anytime with ease. Shoeboxed ensures you will always have your receipts securely stored and ready for tax purposes.

Access your Shoeboxed account from your web browser or smartphone app. Stay audit-ready with Shoeboxed for FREE now!

5 Common Accounting Mistakes Small Businesses Should Avoid

As a small business owner, it’s important to have an efficient and error-free accounting system. It gives you a clear view of how your business is performing, helps you plan strategically, and eases you through the busiest time of the year — tax season. 

That being said, it’s not easy to process such a large volume of data and transactions every day without making any mistakes. That’s why you should be proactive and take precautions. The more aware you are of the most common accounting mistakes, and ways to avoid them, the more likely you’ll be able to prevent any major issues from occurring. 

The following are the top five most common accounting mistakes that small businesses make and how to deal with them. 

Operating without a budget 

A budget is an essential tool to track when and how you earn or spend money. It helps you set realistic financial goals, trim costs to prevent overspending, and make more informed financial decisions. Without a budget, your business wouldn’t have a baseline to adjust financial activities accordingly, meaning you wouldn’t know if you’re overspending or underspending, and when to stop before getting into too much debt. Also, you wouldn’t be prepared for emergencies or unexpected expenses, likely leading to poor decisions. 

In other words, a business budget offers you a path to meet your financial goals.

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Not following a proper accounting procedure 

Many small business owners, self-employed individuals, and freelancers assume that only big corporations need an accounting procedure. This is incorrect because despite having fewer transactions in a month, lacking an accounting procedure still increases your chances of making errors or miscalculations, costing time and money every time you need to fix them. It’s best to set up formal, documented, and detailed procedures for managing bookkeeping and accounting procedures. In addition, to enhance your accounting consistency and accuracy, you may want to create standardized forms and checklists for each activity. For example, below is a checklist of information you have to enter into your accounting software whenever you have a new vendor:

  • Vendor’s name
  • Vendor’s address
  • Telephone number
  • Employer Identification Number (EIN) 
  • Insurance certificates
  • Letters of recommendation
  • Signed contracts. 

At first, you may think this is too complex, unnecessary, and takes up too much time. But in the long run, you will have a smooth and efficient accounting system with minimized accounting mistakes.  

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Neglecting documentation procedures

You may end up losing a lot of money if you fail to document business expenses required for tax deductions. Without the right supporting documentation, the IRS can disqualify your tax write-offs or even penalize you. Here are a few tips to help you maintain a productive documentation system: 

  • Set up new policies: you can  introduce regulations to encourage your employees to store receipts and relevant documents better. For example, your company can only agree to reimburse expense reports if receipts are attached.
  • Go paperless: Paper documents, especially receipts, are easily lost or damaged. That’s why more and more businesses opt to use technology to convert all paper receipts into digital and have them stored securely in the cloud. Shoeboxed — one of the most popular choices on the market — can help you with that. With Shoeboxed, you can digitize every paper receipt in seconds and have your data automatically extracted and categorized. Switching to digital makes documentation procedures a breeze!
  • Only pay when receiving a bill: it’s not that uncommon for a vendor to request payment before issuing an invoice. It is inadvisable to make payments prior to receiving documentation, however,, as it can always be used against you. More importantly, if a dispute arises, you’ll likely lose that money.

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Doing bank reconciliations infrequently 

Another common accounting mistake is not doing bank reconciliations regularly. This mistake is often made by small businesses because they assume that only big companies with a large number of transactions need to do reconciliations. 

Bank reconciliations are vital to every business’s success – it’s the process of comparing your accounting books to bank statements to ensure the data on both documents match and are accurate and correct. By performing bank reconciliations frequently, you can catch mistakes in a timely manner, big or small, and take immediate measures before they get out of hand. A few other benefits that bank reconciliations will bring to your business are: 

  • Prevent fraudulent activities 
  • Keep track of your cash flow 
  • Identify and report bank errors 
  • Detect payments that have bounced or failed to post.

Remember, the longer you go without doing bank reconciliation, the more difficult it will be to catch up, which ends up taking a lot of time, money, and resources. 

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Failing to back up your accounting data 

What would happen if the device on which you kept your company’s financial data was lost, hacked, or stolen, and you didn’t have a backup? You would lose all of your confidential financial data.  

This kind of problem can occur at any time, to anyone. That’s why you should be well prepared in advance by having a backup for your accounting data. It’s quite easy today as many small business accounting software programs allow you to set up an automatic backup of your data. It’s also a good idea to  go through your backup files every now and then to ensure they are all working. That way you know you have everything you need to continue operating your business, even in an emergency situation. 

Final thoughts 

Whether you do your own accounting or hire a professional, making accounting mistakes can result in serious problems for your company. It is better to address and avoid these issues before they escalate and cause far more damage.

Shoeboxed can help you with that. 

Shoeboxed is a helpful receipt scanner software for freelancers, small business owners, and DIY accountants. It helps you clear your piles of documents and turn them digital with ease. Shoeboxed automatically extracts and categorizes important data from your receipts, which then gets manually checked and approved by a team of data experts
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