What is the Financial Accounting Cycle?
The financial accounting cycle is a way through which companies make financial accounting analysis for their business activities. It is used by business owners, companies and organizations alike at their own complexities by adhering to the Generally Accepted Accounting Principles (GAAP principle). This process is extremely important and is done by every company to ensure their prognostic for the financial year or the fiscal year are accurate and their company is performing up to par.
It is an eight step process which assesses the beginning of a business process till its closing. These eight steps are:
- Identifying transactions
This step includes all the transactions that have occurred in a specific time period. Each of these transactions, whether a credit or a debit (asset or liability) needs to be recorded in the company’s books. This process is also called record-keeping. Compared to the traditional methods, this process is now mostly carried out on the Point of Sale (POS) systems within businesses.
- Recording transactions (Journal Entries)
Once all the assets and liabilities have been added, it is time to create a journal entry. These entries are used to create a balance from the credit and the debit side. This is a rule by GAAP and International Financial Reporting Standards (IFRS) and it should be followed strictly.
- Posting entries on ledger
The ledger is where all the entries are further broken down to provide all the activities that may have taken place in a specific time period. An accurate way of assuming the importance of a general ledger is its ability to predict the amount of cash available.
- Creating an unadjusted trial balance
The information of the general ledger is then shifted to the trial balance. As the word unadjusted goes, it shows the balances which need to be adjusted and helps the company fix those issues before posting them on the adjusted trial balance.
- Creating a worksheet
All the information is compiled and checked if it is correct. If there is a need for any adjustments, they are made right away. If there is no need for further corrections, they are posted on the adjusted journal entries.
- Creating adjusted entries
Once all the adjustments have been made, they are tallied on to the adjusted journal entries. Once recorded, the data is ready to be compiled into the financial statements.
- Making financial statements (Income Statement, Balance Sheet, and Cash Flows)
Information is separated from the Journal entries to generate the respective financial statements. As discussed earlier, most of the companies will have an income statement, balance sheet and a cash flow.
- Closing entries
The closing entries are an analysis for the reports which are generated after these seven steps of the financial accounting cycle.
By running these processes, businesses can create an analysis on the business performance by analyzing its assets, liabilities, owners equity and other financial performance aspects. At the time of closing, such information can provide an insight of the future planning and forecasting for any form of business.