One of the biggest challenges for business owners is accounting and tracking their business financial activity. Accounting is a broad term that describes the various ongoing financial activities a business needs to perform. The process that occurs right from sales to end-of-year statements is referred to as an accounting cycle and consists of bookkeeping, classification, summation, trial balances, and interpretation.
These activities can be performed either sequentially or simultaneously with other activities. Although each business generally hires an accountant to handle this aspect of the business, it is critical for a business owner to understand the accounting stages and where the business is in the cycle.
Stage 1: Bookkeeping
The first step in accounting is collecting data. As a business owner, it is important that you note every transaction and the mode in which it occurred (cash, digital, etc.). Each transaction must be listed in chronological order. This is also known as bookkeeping and each entry must be noted for specific time frames with appropriate dates and details. This is a stage of the accounting cycle which is continuous with all the other stages in the cycle and is generally performed every day.
Stage 2: Classification
The next stage is a systematic analysis of the data that’s been collected. No data makes sense unless it is classified or grouped. The first classification done is income or expenses, which can be further grouped according to name, category, account, etc. Depending on the business, there can be further sub-groups based on the nature of the expenses, reimbursements, additional income etc. Classifying your accounts is the best way to understand the financial nature of your business.
This classification and sorting of data are traditionally done in a book called a ledger where there are notes of each transaction as they occur in financial statements. The order generally starts as assets, equity, liabilities followed by the expense and revenue accounts, which are transcribed later on into their respective statements. These days, however, there are several accounting software to do this that save time.
Stage 3: Trial Balancing
Human errors are the common roadblock in financial accounting and a trial balancing should be done to ensure there are no blunders. Accounting software is also used here to reduce human error. The trial balance is done with all credit in one column and the debit in another column. This must be done to prove all mathematical equality between the debits and credits.
Any absent payments or expenses must be met before the accounts can be summarized, and the trial balances are carried over into the summation of the accounts. Any mismatched or erroneous figures can completely change the perception of a business.
Stage 4: Summarizing your Data
Summation of the data is the next step to bringing the classified data together. The summation of the data can be done at the end of each month, quarter and year. This stage is critical to make the transactions and operations of the business understandable to anyone else who reads them, such as; other employees of the business and potential investors. Summarizing of the data may be represented through visual aids such as charts or graphs.
The final summations are the financial statements which include the balance sheets, the statement of cash flow, the balance statement and statement of stakeholders’ equity. The construction of these statements is done by using the information from the trial balance to fill out any statement accounts with the amount in account balances. Software like Quick Books among others are great at producing these documents automatically. Lastly, all temporary accounts should be closed to show a zero balance before the start of the next financial year.
Stage 5: Interpretation
Interpretation is the final stage in the accounting cycle and is the most critical tool to make any decisions concerning the business. This allows end-users to make a judgment on the financial status of a business as well as the profitability of the business. This is then used to make financial decisions regarding the business and frame financial policies accordingly. Once this is done, the cycle begins again and transaction data are again submitted for accounting.
Business owners require small business funding all year around. As a business owner, when you are trying to expand, hire more staff, or buy more inventory, it’s important to understand your business finances. This requires strictly following each stage in the accounting cycle and preparing each financial report accordingly. These practices will help promote a healthy business and in case of any additional financial requirements, Reliant Funding is always here to help.