Accounting is an essential aspect of any business, and trading businesses are no exception. All organisations require accounting because dealing with numbers is not an easy task; and as a business, keeping a record of all transactions is crucial in the long run. The recorded information may be needed for various purposes, such as making important business decisions based on financial data.
For trading businesses in the UAE, the accounting cycle can be a complex process due to the diverse nature of their operations and the regulatory environment in which they operate. Therefore, by understanding the accounting cycle, trading businesses can better manage their finances, comply with regulations, and make informed decisions for their future growth and success.
In this article, we will explore what the accounting cycle for trading business is, various accounting cycle steps and their importance.
What is an Accounting Cycle?
The term “accounting cycle” is often used in economic activities especially when it comes to trading businesses. So, what exactly is it? Simply put, it refers to the process of preparing the company’s financial statements for a specific period of time.
The cycle typically begins with recording transactions and ends with the preparation of the company’s financial statements. This is followed by closing the balance with closing journals or until the reversing journal is completed. These recorded pieces of information serve as the basis for key insights upon which the company’s economic future is determined.
Understanding the accounting cycle in detail
Trading operations heavily rely on accounting for their success. Due to the comprehensive and detailed nature of merchandising operations, obtaining insights from them is only possible through professional accounting services. As a trading business owner, if you have been facing challenges in managing crucial business information, it is important to recognize the significance of the accounting cycle.
Based on a list of related activities, the complete cycle of merchandise operations involves the following steps:
1. Originating Data
The accounting process begins with the collection of data. The originating data may include the number of products sold, daily profit percentage, sales revenue, expenses incurred, and other financial transactions that occur in the day-to-day operations of a trading business. For instance, a retail store needs to keep track of the inventory it has on hand, the number of products sold each day, and the price at which they were sold. Such data provides valuable insights into how the business is performing and helps business owners make informed decisions.
Once the originating data is collected, it needs to be accurately calculated and recorded in the company’s books. Journalising involves creating a journal entry that records each transaction in chronological order. For instance, every sale made by a retail store needs to be recorded in the books, along with the corresponding amount received and any expenses associated with the sale, such as taxes or shipping fees. Similarly, all purchases made by the business, such as inventory, office supplies, or other materials, must also be recorded in the books.
3. Updating the Data in the Ledger
After journalising, the next accounting cycle step is to post the transaction data to the appropriate accounts in the ledger. The ledger contains a detailed record of all financial transactions made by the business, including revenues, expenses, assets, liabilities, and equity. Posting involves transferring the data from the journal to the ledger, where it is grouped according to specific accounts.
Maintaining a worksheet is an essential part of the accounting cycle. The worksheet serves as an interim report that summarises the information recorded in the ledger and allows business owners to review the financial health of their business. It provides an overview of the company’s assets, liabilities, equity, revenues, and expenses for a specific period, usually a month, quarter, or year. The worksheet is also used to make adjusting entries, which ensure that the financial statements accurately reflect the company’s financial position.
5. Financial Statements
Financial statements provide a snapshot of the company’s financial performance and position, enabling business owners to make informed decisions. The financial statements typically include an income statement, a balance sheet, and a cash flow statement. The income statement shows the company’s revenues and expenses over a specific period, while the balance sheet provides a summary of the company’s assets, liabilities, and equity. The cash flow statement shows how the company generated and used its cash during the period. Making sure that the statements are accurate and remain free of any sort of misrepresentation is particularly vital.
6. Adjusting and Closing Entries
Adjusting entries are made to correct any errors or omissions in the company’s financial records. For instance, adjusting entries may be required to account for accrued expenses, such as unpaid wages or taxes. Closing entries, on the other hand, are made at the end of the accounting period to transfer the balances of temporary accounts, such as revenues and expenses, to the company’s retained earnings account. This process prepares the books for the next accounting period.
7. Post-closing Trial Balance
The post-closing trial balance is the final component of all accounting cycle steps. It is used to ensure that the company’s books are in balance and that all transactions have been recorded correctly. The post-closing trial balance includes all the accounts that appear on the company’s balance sheet, and it should show that the total debits equal the total credits.
Importance of the Accounting Cycle Steps
The entire accounting cycle involves dozens of interdependent activities that must be undertaken as an interconnected chain. Each step that we have mentioned above is important for a number of reasons. They are as follows:
Every step in an accounting cycle is crucial, and missing one can result in errors and inaccuracies in the financial statements. This is because all activities in the accounting process are interdependent and linked to each other.
For instance, you cannot prepare the adjusted trial balance accurately if the entries in the unadjusted trial balance have not been adjusted correctly. Therefore, the accuracy of one activity depends on the accuracy of the preceding activity.
2. Dissemination of Information
Financial information needs to be communicated to stakeholders, including investors, management teams, and regulatory bodies, in a timely and accurate manner. The accuracy of the financial information relies on the accuracy of the preceding activities. If the results of the preceding activities are inaccurate, the financial statements will also be inaccurate, and this can lead to faulty decision-making by stakeholders. Hence, the dissemination of accurate financial information is critical for the success of the organisation.
3. Updating Accounts
Temporary accounts, such as revenues, expenses, and dividends, need to be zeroed out after the dissemination of financial information. These updates cannot be done without the correct tracking and monitoring of ledger accounts and transactions. The retained earnings account needs to be kept dormant until the closing process is concluded by accounting and bookkeeping professionals. Once the closing is completed, the earnings accounts must be updated to reflect the changes in the temporary accounts.
The accounting cycle is a transitional process, where each step is connected to the next. For example, temporary accounts must be zeroed out while real accounts are carried forward to the next phase of accounting. This process ensures that the financial statements accurately represent the financial position of the organisation. Therefore, each step in this cycle is necessary for the successful completion of the process, and any missing step can result in errors and inaccuracies in the financial statements.
5. Ensuring Compliance
Accounting is not just about keeping track of financial information but also adhering to legal and regulatory requirements. By accurately completing each step of the accounting process, businesses can ensure that they are meeting all the relevant compliance standards.
6. Better Decision-making
Having the right financial information at your fingertips is paramount for making informed business decisions. All accounting cycle steps, from recording transactions to producing financial statements, contribute to providing accurate and timely information that can be used to make strategic decisions.
Accurate accounting records are essential for internal and external auditing purposes. By conducting each and every step of the accounting process accurately and thoroughly, businesses can facilitate auditing procedures and ensure that they are prepared for any audits that may arise.
The accounting cycle is truly a crucial process for any trading business. It helps to maintain accurate financial records, facilitates decision-making, and ensures compliance with legal and regulatory requirements. By following the accounting cycle steps, businesses can identify and rectify errors in their financial statements, thus avoiding costly mistakes.
At NNCA, we understand the importance of the accounting cycle and how it can impact or transform your business. So don’t spend your valuable time on things that eat up your company resources. Allow us to handle your company’s accounting for you, so you can focus on what you do best – running your business. Our team of experienced accountants and financial experts can provide tailored solutions to help streamline your business operations and achieve your financial goals.
Contact us today at firstname.lastname@example.org or give us a call at +97143577678 to learn more about our accounting services and how we can help your business grow.