Master the Accounting Cycle steps: Your guide to tracking business finances like a pro

Running a business or learning accounting and feeling overwhelmed by all the “numbers talk”? Don’t worry — we’ve got your back! Whether you’re a total beginner or halfway through your accounting course but still confused, this guide will break down the Accounting Cycle in a way that finally makes sense.

So, let’s start at the beginning…

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What is a transaction (and why should you care)?

Imagine you’re hungry, and you walk into a shop to buy a snack. You pay with cash — easy, right? That’s a cash transaction.

But what if you say, “Hey, I’ll pay you Friday!” That’s still a transaction, even though no cash moved. That’s called a credit transaction.

In accounting, every transaction affects at least two accounts. For example, when you buy that snack with cash:

• Cash goes down.
• Snacks (Inventory) goes up.

That’s where bookkeepers come in — they track these movements by recording them properly.

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What’s an account, anyway?

An account is just a record of a particular item or activity in a business. It could be:

• Assets (things you own)
• Liabilities (what you owe)
• Income (what you earn)
• Capital (owner’s investment)
• Expenses (what you spend)

Bookkeepers use something called the double-entry system, which simply means: every transaction has two sides — debit and credit. These are recorded during a specific time frame called the accounting period.

👉 We dive deeper into accounts and double-entry in other videos, so be sure to like, subscribe, and stay tuned for more easy-to-understand lessons.

Now let’s get to the big question…

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What is the Accounting Cycle?

The Accounting Cycle is the full journey of a transaction — from the moment it happens to the moment it’s turned into financial reports. Think of it like tracking a parcel from order to delivery!

There are 7 steps in the Accounting Cycle:

🧾 Bookkeeper’s job (first 4 steps):

1. Source documents
2. Journals
3. Ledgers
4. Trial Balance

Accountant’s job, financial statements (last 3 steps):
5. Income Statement
6. Balance Sheet
7. Cash Flow Statement

Let’s break it down…

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Step 1: Source documents – where it all begins. The evidence

A source document is proof that a transaction happened. No document, no record!

Examples include:

• Receipts
• Invoices
• Bills
• Bank statements
• Cheques
• Contracts
• Payroll reports
• Purchase orders
• Credit/debit notes
• Emails (yup, even digital confirmations count!)

Bookkeepers first organise these documents into:

• Cash transactions (money moved immediately)
• Credit transactions (payment is delayed)

This sets the stage for the next step.

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Step 2: Journals (aka day books). The first record

Now that we’ve sorted our documents, it’s time to record them in Journals. These are like the daily diary of your business activities.

There are 7 main types of journals:

For goods bought/sold on credit (non-cash):

1. Purchases journal
2. Sales journal
3. Returns inward journal (returns from customers)
4. Returns outward journal (returns to suppliers)

For cash transactions:
5. Cash Book – for big amounts (e.g. over $200 or a custom threshold)
6. Petty Cash Book – for small day-to-day expenses

For everything else:
7. General journal – handles:

• Asset purchases on credit
• Depreciation
• Bad debts
• Error corrections
• Opening balances

Think of Journals as the first draft before the clean copy.

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Step 3: Ledgers – where the magic happens

Next, bookkeepers post the journal entries into Ledgers using T accounts. This is where things start looking more like traditional accounting.

There are 3 key ledgers:

• General ledger – holds everything
• Purchases ledger – tracks what you owe suppliers
• Sales ledger – tracks what customers owe you

Each account gets “balanced off” at the end of the period.

✅ If a buyer pays what they owe, we close the account.
🔄 If they still owe money, the account remains open and is carried forward.

It’s like clearing your inbox — mark “done” or “follow up later”.

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Step 4: Trial Balance – time to check your work

Once the ledgers are balanced, the bookkeeper creates a Trial Balance — a list of all account balances showing debits and credits.

Ideally, both sides should match. But if they don’t — it’s detective time!

Also, there are six types of accounting errors that do not affect the trial balance. These are errors of omission, errors of commission, errors of principle, compensating errors, errors of original entry, and complete reversal of entries. 

These errors might not be detected by the trial balance because they either involve the omission of a transaction, the posting of a transaction to the wrong account, or a combination of errors that cancel each other out. 

Common tools used to find and fix errors:

• General journal (to adjust entries)
• Suspense Account (temporary holding place for unknown errors)
• Control accounts
• Bank reconciliation statements
• Draft profit & revised profit statements

Mistakes happen — this step makes sure everything adds up before moving on to the financial statements.

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Step 5: Income Statement – did you make a profit?

Also known as the Profit and Loss Statement, this report tells you:

• How much you earned (Income)
• How much you spent (Expenses)

From this you calculate:

• Gross profit = Sales – Cost of Goods Sold
• Net profit = Gross Profit – Operating Expenses

💡 If net profit is positive — your business made money.
😬 If it’s negative — you made a loss.

This report is a key indicator of how your business is performing over a period.

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Step 6: Balance Sheet – your business snapshot 📷

The Balance Sheet, or Statement of Financial Position, shows what your business owns and owes at a specific point in time.

It includes:

• Assets (cash, buildings, inventory, etc.)
• Liabilities (loans, accounts payable, etc.)
• Capital/equity (owner’s investment + profits)

It also uses the Net Profit from the Income Statement to update equity.

🧮 Business owners use financial ratios from this and the Income Statement to make smart decisions, like:

• Should I expand?
• Can I afford a loan?
• Am I overspending?

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Step 7: Cash Flow Statement – where’s the money going? 💵

This report tells the real story behind your cash:

• Operating activities – day-to-day running of the business
• Investing activities – buying or selling assets
• Financing activities – loans, capital injections, etc.

The Cash Flow Statement shows how cash is generated and used. It works hand-in-hand with the Income Statement and Balance Sheet to give a full picture of your business’s liquidity and financial health.

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🎯 Conclusion: Why the Accounting Cycle matters

The Accounting Cycle isn’t just for accountants — it’s for anyone who wants to truly understand their money.

Let’s recap the 7 steps:

1. Source documents
2. Journals
3. Ledgers
4. Trial Balance
5. Income Statement
6. Balance Sheet
7. Cash Flow Statement

Once you master this cycle, you’ll be able to:

• Track your finances clearly
• Spot problems early
• Make smarter decisions
• Grow your business confidently

So go ahead — bookmark this guide, review it often, and start seeing your business (or studies) in a whole new light.

👋 Don’t forget to Like, Subscribe, and leave a comment if you want more deep dives into accounting made simple. You’ve got this!

See also:

ALICE: Assets, Liabilities, Income, Capital, Expenses

Accounting Cycle: Complete basic accounting in 8 steps

Goods for resale: Stock, Purchases, Sales, Carriages and Returns

Debit and Credit: Simple view of in and out

Increase and decrease of ALICE accounts

Expenses: Spending that’s direct, indirect, operating and non-operating

Income: Earned, unearned and contributed money

Cash Book: How to record cash, bank and discounts

Journals: Complete 7 Day Books with 4 types of transactions

Ledger accounts: Simple breakdown of Types, Format, Double Entry, Balance

Liabilities: Owed long and short-term items with a credit balance

Capital: Invested assets and the liquidity of a business