Even as accounting takes much effort and time, small business owners need to know the basics. Every year, you get to see the state of your finances through a process called the “accounting cycle.” This involves the recording of every transaction that the company entered into, up to the year-end closing of accounts to start the following business year anew. There are several steps in the accounting cycle that small business owners should familiarize themselves with to monitor the state of their business’ finances.
1. Create a chart of accounts and general ledger
The index of all accounts about the company’s financial information is called the chart of accounts. The chart of accounts has two main parts – the balance sheet and income statement. The balance sheet accounts are where all data related to existing assets and liabilities are filed for future analysis. On the other hand, the income statement accounts show the direction of cash flow. Data on revenues, losses, and expenses are recorded in this section of the chart of accounts. You can create a template chart of accounts where all future transactions can be filed for review.
You and other business parties can also undertake the General Ledger format for your small business to see. Filling the general ledger weekly or even daily is a must to prevent mistakes. Reviewing your entries also lets you know if there are more changes and deviations. Since it is summarized, all you have to do is to contextualize and put them together to see the bigger picture.
2. Make accounting entries
After you create a chart of accounts, you need to have a journal that details the specific accounting entries in your sheet – the nature of payments, date, name of client or person, and amounts involved. Accounting records also enable you to determine delinquents payers, income, and tax liabilities.
3. Gather the source documents for each transaction
When you make an entry on your chart of accounts, you need to back it up with evidence. Receipts, invoices, and purchase orders are among the documents that need to be sorted out. Ideally, this paperwork should be filed immediately after every transaction. Some business owners are too complacent that they choose to cram the submission of proof or travel documents. Complacency and laziness in entering data can cause costly mistakes.
4. Prepare a trial balance
Once your general ledger is complete for a given accounting cycle calendar, you have to calculate a trial balance. The trial balance involves finding the difference between your credits and debits to see if you’re nearing budgetary constraints. The trial balance also allows you to discover inconsistent data or discrepancies.
5. Review, adjust, correct, and reconcile the entries you made
If you enter financial data and transactions in your ledger and chart of accounts manually, it is possible to make mistakes in your entry. These mistakes will show up when you do a trial balance. Take the opportunity to make adjustments, corrections, and reconciliations of your financial data and information. You will use these data as the basis for your managerial and financial accounting reports.
6. Summarize your cash flow findings through Financial Statements
Gather the relevant and important totals and percentages from your ledgers and accounting journals to create a financial statement summarizing your business’ performance. Among the types of data that you need to highlight are the income statement, net cash flow, existing balance, and comparisons of performance compared to last year.
7. Close your entries at the end of your Accounting Cycle
In preparation for next year’s business period, you have to close your revenue, expense, and drawing accounts and set them to zero. However, your assets accounts would stay in their current state.