Types of Transaction Cycles in Accounting

by Osmond Vitez; Updated September 26, 2017

Every business activity can be traced to specific accounting cycles, which are critical when analyzing businesses individually and as part of a larger industry. Identifying these cycles and the specific activities within them are essential to determining the effectiveness and profitability of a business. Businesses engage in multiple financial transactions during normal operations, and accurate reporting of each accounting transaction cycle helps determine the profitability of a process or product.

Financial Cycle

Knowing how to determine the starting point and interaction of one cycle to the next is a critical step in understanding the workflow operations. Once each step is identified, management can assess the effectiveness of each cycle. The starting point for each business is the financial cycle, which consists of how the business obtains the initial capital for funding operations. The capital may come from the owner, venture capitalists or through a bank loan. The amount of start-up capital is usually based on financial projections relating to needs of the business, such as buildings, equipment, licenses and inventory.

Expenditure Cycle

Based on the projections from the financial cycle, businesses begin spending their budget on materials needed for inventory. Goods may be raw materials for manufacturing, food products for a restaurant, tools for repair personnel or vehicles for a delivery service.

Payroll Cycle

The payroll cycle is the process of hiring personnel to conduct the daily operations of the business. Most businesses have several layers of personnel, from frontline service workers, shift management, secretarial staff, accountants and executive management. Each class of workers may have different pay scales and bonus levels, creating unique accounting needs for the payroll cycle.

Conversion Cycle

The conversion cycle is the crux of each business; daily transactions from normal operations include pieces from the expenditure and payroll cycle to make up the conversion process. The goods purchased for the business are used by the personnel from payroll to earn the business cash. A large portion of accounting transactions will occur in this phase because of the repetitious conversion activities of business operations.

Revenue Cycle

A large amount of accounting transactions also will occur in the revenue cycle. This cycle includes the transactions relating to the sales of goods and services to customers and any expenses related to those revenues. Revenues can only be generated once the conversion cycle is complete; unfinished goods or services are not reported in the revenue cycle until the completion of the previous cycle.

Accounting Transaction Cycle

Inside each previous transaction cycle are more detailed and specific information: the accounting transactions. These transactions consist of the daily paperwork generated by the individual activities of each previous cycle. Purchase orders, payroll checks, job tickets and sales invoices are found in each step of the accounting cycles. Paperwork generated from each cycle must be analyzed for validity before being entered in the accounting information system. After the numbers are verified and entered in the system, trial balance reports and financial statements are generated to determine the company’s profitability.