Whether you perform bookkeeping in the nonprofit or for-profit world, knowledge of the accounting cycle is a crucial asset. It helps paint a clear picture of your organization’s financial health. But, what is the accounting cycle? We define it here, along with the eight essential steps to understand.

The accounting cycle defined

The accounting cycle is an accounting term that any business owner should recognize and appreciate. It’s an eight-step process that tracks, records, and analyzes all financial activities, helping to keep financials orderly, protect assets, and make reporting easier. It ensures that every penny that changes hands during the accounting period is accounted for and accurately reflected in financial statements. The accounting cycle is like a checklist of tasks to complete at the end of every accounting period. Once complete, you may start the next accounting period with a clean slate.

The eight steps of the accounting cycle include:

1. Identify transactions
2. Prepare journal entries
3. Post transactions to the ledger
4. Create the unadjusted trial balance
5. Analyze worksheets
6. Prepare adjusting journal entries and an adjusted trial balance
7. Generate financial statements
8. Close the books

Identify transactions

When any financial activities or business events occur, those transactions are recorded in the books and included in the financial statements. A nonprofit’s revenue and expenses differ from that of a for-profit business. For example, nonprofit revenue sources may consist of donations, program fees, sales income, membership dues, investment income, and proceeds from fundraising events. Nonprofit expenses may include rent, salaries, travel, postage, financial services, and fundraising expenses. All are considered transactions.

Prepare journal entries

Once you’ve identified all of your financial transactions for the accounting period, you must create journal entries for each. Preparing journal entries used to be a time-consuming manual process. Today, accounting software programs make organizing and recording all of the transactions much more efficient and with fewer inaccuracies.

Post transactions to the ledger

Once the transaction is entered as a journal entry, it should be posted to an account in the general ledger. The general ledger is where all transactions are posted throughout the year, and the balances are maintained. It’s essentially a summary sheet where all transactions are properly categorized in one place.

Create the unadjusted trial balance

The first three steps of the accounting cycle occur during the accounting period. The calculation of the unadjusted trial balance happens once the period has ended and all transactions have been identified, recorded, and posted to the general ledger. Generating an unadjusted trial balance quickly shows if your balances are off. If they are, it signifies that there are discrepancies.

Analyze worksheets

If your unadjusted trial balance is off, you can conduct a worksheet analysis to help determine why. Since the unadjusted trial balance shows all your debits and credits in a table, it’s a great tool that quickly identifies errors.

Prepare adjusting journal entries and an adjusted trial balance

Once you’ve discovered any discrepancies, you’ll need to prepare adjusting journal entries to correct them. Adjusting entries may be required for revenue and expense matching or to correct accruals or deferrals. An example of an adjusting journal entry is when a bill is paid later in the accounting period. Since the bill had been recorded in accounts payable when it initially occurred, it’s a transaction that requires an adjustment to remove the charge. Once you’ve entered your adjusting journal entries, double-check your work by generating an adjusted trial balance. It shows your unadjusted trial balance, adjusting entries, and adjusted amounts. At this point, everything should balance out.

Generate financial statements

Once your adjusted trial balance is correct, you may generate your financial statements for the accounting period. For example, a for-profit company would create a balance sheet, income statement, and cash flow statement. A nonprofit would generate a statement of financial position, a statement of activities, and a statement of cash flow.

Close your books

An organization completes the accounting cycle in this final step. The goal is to close the books on the specified closing date by the end of the day. Once the books are closed, the next accounting cycle starts with a new reporting period. Closing the books also signifies an ideal time to file paperwork, review upcoming events and tasks, and strategize for the next reporting period.

This eight-step accounting cycle helps ensure your organization’s financials are consistently accurate. While the process may seem daunting, a good accounting software program (like Intacct) makes it much simpler and faster. Of course, another sensible option is to outsource your accounting to an expert accounting team, like Qbix. It’s never too late to optimize your financial procedures. You’ll make life easier for yourself while enhancing and strengthening the health of your organization. Why wait? Schedule your free consultation call today. 

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